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SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH I. INTRODUCTION AND OVERVIEW ................................................................ 7 1. 2. Moveable and Immovable Security Interests ..............................................................................................7 Federal/Provincial Issues ...........................................................................................................................7 II. FORMAL AND FUNCTIONAL CONCEPTS OF SECURITY ......................... 7 A. 1. CONSENSUAL AND NON-CONSENSUAL CONCEPTS OF SECURITY .....................................................................7 Consensual and Non-Consensual Security in the CCQ ..............................................................................7 CCQ 2664 ............................................................................................................................................... 8 2. Consensual and Non-Consensual Security in the Common Law ................................................................8 B. HYPOTHECARY AND TITLE-BASED CONCEPTS OF SECURITY ...........................................................................8 1. Concepts of Security in the CCQ ................................................................................................................8 a. b. c. d. e. 2. Concepts of Security in the PPSA ............................................................................................................. 12 a. C. 1. Hypothec ............................................................................................................................................................... 9 CCQ 2660 ............................................................................................................................................... 9 Sale with the Right of Redemption .................................................................................................................... 9 CCQ 1750 ............................................................................................................................................... 9 CCQ 1756 ............................................................................................................................................. 10 Security Trust ..................................................................................................................................................... 10 CCQ 1263 ............................................................................................................................................. 10 Instalment Sale .................................................................................................................................................. 10 CCQ 1745 ............................................................................................................................................. 11 CCQ 1749 ............................................................................................................................................. 11 Leasing ................................................................................................................................................................ 11 CCQ 1842 ............................................................................................................................................. 11 CCQ 1847 ............................................................................................................................................. 11 Security Interest (Comprehensive) .................................................................................................................. 12 ON PPSA 1 (definitions) ...................................................................................................................... 12 ON PPSA 2(a) ...................................................................................................................................... 12 TRANSACTIONS “DEEMED” TO BE SECURED TRANSACTIONS ......................................................................... 13 Assignments .............................................................................................................................................. 13 a. b. 2. Assignments in the CCQ .................................................................................................................................. 13 CCQ 1642 ............................................................................................................................................. 13 Assignments in the PPSA................................................................................................................................. 14 ON PPSA 2(b) ...................................................................................................................................... 14 Operating Leases ...................................................................................................................................... 15 a. Leases and Leasing in the CCQ (why are we dealing with this twice?) ................................................... 15 CCQ 1851 ............................................................................................................................................. 15 CCQ 1852 ............................................................................................................................................. 15 The CCQ does not distinguish between a financial lease and an operating lease with a term of greater than one year, unlike the PPSA. ......................................................................................................................................... 15 b. Operating Leases in the PPSA ........................................................................................................................ 15 The PPSA does distinguish between a financial lease and an operating lease with a term of greater than one year, unlike the CCQ. .................................................................................................................................................. 15 ON PPSA 2(c) ...................................................................................................................................... 15 3. Consignments ........................................................................................................................................... 16 4. Sale of Goods Without a Change of Possession ....................................................................................... 16 NB PPSA 3(2)(a) .................................................................................................................................. 16 NB PPSA 3(2)(d) .................................................................................................................................. 16 II. CREATION OF (CONSENSUAL) SECURITY RIGHTS ................................ 17 A. B. GENERAL CONSIDERATIONS .......................................................................................................................... 17 GRANTING SECURITY TO SECURE THE OBLIGATION OF A THIRD PERSON ..................................................... 17 1. Securing the Obligations of a Third Person in the CCQ .......................................................................... 17 CCQ 2681 ............................................................................................................................................. 17 2. Securing the Obligations of a Third Person in the PPSA ......................................................................... 18 ON PPSA 1(1) ...................................................................................................................................... 18 C. PERMISSIBLE PARTIES .................................................................................................................................... 18 1 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH 1. Permissible Parties in the CCQ ................................................................................................................ 18 CCQ 2683 ............................................................................................................................................. 19 CCQ R. 5 Regulation respecting the register of personal and movable real rights ............................... 19 Art. 15.01 .............................................................................................................................................. 19 CCQ 2684 ............................................................................................................................................. 20 2. Permissible Parties in the PPSA............................................................................................................... 21 NB PPSA s. 13 ..................................................................................................................................... 21 C. EXEMPT ASSETS ............................................................................................................................................. 21 1. Exempt Assets in the CCQ ........................................................................................................................ 21 CCQ 2668 ............................................................................................................................................. 21 2. Exempt Assets in the PPSA ....................................................................................................................... 21 NB PPSA 58(3) .................................................................................................................................... 21 D. REQUIREMENTS FOR CREATION/ATTACHMENT OF SECURITY RIGHTS ........................................................... 22 In brief: .............................................................................................................................................................. 22 ON PPSA 11 ......................................................................................................................................... 22 1. Existence of Secured Obligation ............................................................................................................... 23 a. b. Existence of Secured Obligation in CCQ ....................................................................................................... 23 CCQ 2661 ............................................................................................................................................. 23 CCQ 2687 ............................................................................................................................................. 23 CCQ 2688 ............................................................................................................................................. 23 CCQ 2691 ............................................................................................................................................. 23 Existence of Secured Obligation in PPSA ...................................................................................................... 23 ON PPSA 11(2) .................................................................................................................................... 23 ON PPSA 13 ......................................................................................................................................... 24 Grantor’s Right in Collateral ................................................................................................................... 24 2. a. b. 3. Grantor’s Right in the CCQ .............................................................................................................................. 24 CCQ 2666 ............................................................................................................................................. 24 CCQ 2670 ............................................................................................................................................. 24 Grantor’s Right in the PPSA ............................................................................................................................. 24 ON PPSA 11(2) .................................................................................................................................... 24 ON PPSA 12 ......................................................................................................................................... 25 Evidence of a security agreement ............................................................................................................. 25 a. b. Evidence of a security agreement in the CCQ .............................................................................................. 25 Evidence of a security agreement in the PPSA ............................................................................................. 26 ON PPSA 9 ........................................................................................................................................... 26 ON PPSA 11 ......................................................................................................................................... 26 III. THIRD PARTY EFFECTIVENESS (PUBLICATION/PERFECTION) ........... 29 A. CREATION/ATTACHMENT, PERFECTION/PUBLICATION, AND PRIORITY .......................................................... 29 B. PURPOSES OF PERFECTION/PUBLICATION....................................................................................................... 29 THE PURPOSE OF PERFECTION/PUBLICATION IS TO PROTECT THIRD PARTIES BY ENABLING THEM TO LEARN OF THE SECURITY INTEREST. ................................................................................................................................................ 29 PERFECTION/PUBLICATION IS ALSO RELATED TO PRIORITY, IN THAT IT PROVIDES AN EFFICIENT MEANS OF ORDERING PRIORITY RANK BETWEEN SECURED CREDITORS. ..................................................................................................... 29 C. CONSEQUENCES OF FAILURE TO PERFECT/PUBLISH ....................................................................................... 29 1. Failure to Publish in the CCQ .................................................................................................................. 29 CCQ 2663 ............................................................................................................................................. 29 CCQ 2703 ............................................................................................................................................. 29 CCQ 2934 ............................................................................................................................................. 30 CCQ 2941 ............................................................................................................................................. 30 2. D. Failure to Perfect in the PPSA ................................................................................................................. 30 NON-HYPOTHECARY SECURITY RIGHTS ......................................................................................................... 31 1. Publication Requirement for Non-hypothecary Security Devices ............................................................ 31 CCQ 1263 ............................................................................................................................................. 31 CCQ 1745 ............................................................................................................................................. 31 CCQ 1750 ............................................................................................................................................. 31 CCQ 1756 .............................................................................................. Error! Bookmark not defined. CCQ 1847 ............................................................................................................................................. 32 Leasing: ............................................................................................................................................... 32 2 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH The rights of ownership of the lessor have effect against third persons only if they have been published; effect against third persons operates from the date of the leasing contract provided the rights are published within 15 days. ............................................................................................................... 32 CCQ 1852 ............................................................................................................................................. 32 2. Non-Hypothecary Security Devices and Bankruptcy ................................................................................ 32 Giffen (BC PPSA, 1998) – Iaccobucci .................................................................................................. 32 Lefebvre (CCQ, 2004) – LeBel............................................................................................................ 33 Ouellet (CCQ, 2004) – LeBel .............................................................................................................. 34 BIA s. 2................................................................................................................................................. 34 E. 1. 2. EFFECT OF CHANGE OF MODE OF PUBLICATION/PERFECTION........................................................................ 35 Change of Mode of Perfection in the PPSA .............................................................................................. 35 Change of Mode of Publication in the CCQ ............................................................................................. 35 CCQ 2707 ............................................................................................................................................. 35 F. AUTOMATIC PUBLICATION/PERFECTION ........................................................................................................ 35 SOMETIMES A SECURITY RIGHT IS TREATED AS AUTOMATICALLY PUBLISHED/PERFECTED (IE, CREATION IS SUFFICIENT FOR PUBLICATION/PERFECTION). ........................................................................................................... 35 1. Automatic Perfection in the PPSA ............................................................................................................ 37 As per ON s. 24.2 and NB s. 26.1, certain kinds of security interest may be perfected by possession, and remains perfected for the first ten days (ON) or fifteen days (NB) after the collateral comes under the control of the debtor. This is most commonly applied to instruments (eg, cheques, promissory notes), certificated securities, and documents of title (eg, bills of lading or warehouse receipts). .................................................. 37 A negotiable document of title operates as the equivalent of goods for the purpose of transferring title to the buyer. It can thus serve as collateral; the buyer will obtain financing from the bank to purchase goods, and the bank will take a security interest in the bill of lading as collateral. This is usually a short-term financing, because the buyer will sell the goods in turn, which means the bank must relinquish the bill of lading. It is impractical for the bank to register their security interest, because they will likely relinquish the bill of lading within a few days. Therefore, the interest remains perfected for the first 10 or 15 days after the bill of lading is returned to the buyer. After this time, the bank has to register to maintain continuous priority. ...................... 37 2. Automatic Perfection in the CCQ ............................................................................................................. 35 CCQ 2703 ............................................................................................................................................. 36 CCQ 2704 ............................................................................................................................................. 36 CCQ 2706 ............................................................................................................................................. 36 CCQ 2708 ............................................................................................................................................. 36 Blouin – READ THIS CASE! ................................................................................................................ 37 CCQ 2710 ............................................................................................................................................. 36 CCQ 2711 ............................................................................................................................................. 36 IV. REGISTRATION ........................................................................................... 38 A. TYPE OF REGISTRY SYSTEM ........................................................................................................................... 38 B. ADVANCED REGISTRATION ............................................................................................................................ 39 1. Advanced Registration in the PPSA ......................................................................................................... 39 2. Advanced Registration in the CCQ ........................................................................................................... 39 3. Policy Justifications for Advanced Registration ....................................................................................... 39 CCQ 2969 ............................................................................................................................................. 38 CCQ 2944 ............................................................................................................................................. 40 THE REGISTRATION OF A HYPOTHEC AGAINST SOMEONE’S ASSETS IMPAIRS HIS ABILITY TO GET ADDITIONAL SECURED CREDIT, BECAUSE POTENTIAL CREDITORS WILL KNOW THEY ARE SECOND PRIORITY. ERROR! BOOKMARK NOT DEFINED. THIS IS WHY ON DOES NOT PERMIT ADVANCED REGISTRATION FOR CONSUMER GOODS, FOR EXAMPLE. ....... 40 OTHER PROVINCES DO PERMIT THIS, HOWEVER, ARGUING THAT REGISTRATION IS NOT EVIDENCE OF THE EXISTENCE OF A SECURITY RIGHT; IT MERELY SIGNALS THAT A RIGHT MAY EXIST. ................................................. 40 C. REQUIRED REGISTRATION INFORMATION ...................................................................................................... 41 1. Maximum Value ........................................................................................................................................ 41 a. Policy Justifications for Maximum Value ........................................................................................................ 41 D. EFFECT OF ERROR OR OMISSIONS .................................................................................................................. 42 ERRORS AND OMISSIONS USUALLY ARISE IN CONNECTION WITH THE GRANTOR’S LEGAL NAME, PARTICULARLY WHERE THE GRANTOR IS A NATURAL PERSON. ......................................................................................................... 42 3 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH RECALL THAT MOVABLE REGISTRIES ARE INDEXED ACCORDING TO THE GRANTOR’S NAME. .... ERROR! BOOKMARK NOT DEFINED. SOME COMMON LAW JURISDICTIONS PERMIT NATURAL PERSONS TO USE NICKNAMES AND OTHER FORMS ON LEGAL DOCUMENTS, WHILE OTHERS DO NOT. .................................................... ERROR! BOOKMARK NOT DEFINED. THESE INCONSISTENCIES POSE GREAT CHALLENGES TO ELECTRONIC SYSTEMS, PARTICULARLY WHEN IT COMES TO THE VALIDITY OF THE REGISTRATION. ............................................... ERROR! BOOKMARK NOT DEFINED. O SAY I BUY A CAR UNDER A NICKNAME, AND REGISTER UNDER MY NICKNAME. ........ ERROR! BOOKMARK NOT DEFINED. O A SECURED CREDITOR SEARCHES UNDER MY LEGAL NAME, AND NOTHING COMES UP: IS THE REGISTRATION VALID? ............................................................................................................... ERROR! BOOKMARK NOT DEFINED. THE COURT’S TEST IS WHETHER THE ERROR/OMISSION WOULD MISLEAD A REASONABLE SEARCHER IN A MATERIAL WAY. THE UNDERLYING QUESTION IS WHAT THE SYSTEM ACCEPTS AS A LEGAL NAME. ........................................... 42 Lambert (ON PPSA, 1994) .................................................................................................................. 42 Exode Automobile Inc. (CCQ) ............................................................................................................ 44 V. COMPETING CLAIMANTS: PRIORITY AMONGST SECURED CREDITORS 44 A. 1. GENERAL RULE .............................................................................................................................................. 44 First to Publish Rule in the CCQ .............................................................................................................. 44 CCQ 2941 ............................................................................................................................................. 44 2. First to Register Rule in the PPSA ........................................................................................................... 44 B. KNOWLEDGE/NOTICE OF AN UNPUBLISHED/UNPERFECTED RIGHT ................................................................ 45 1. Knowledge in the CCQ ............................................................................................................................. 45 CCQ 2963 ............................................................................................................................................. 45 2. C. 1. 2. 3. D. 1. Knowledge in the PPSA ............................................................................................................................ 45 PRIORITY WITH RESPECT TO LATER ADVANCES ............................................................................................ 45 Priority and Later Advances in the CCQ.................................................................................................. 45 Priority and Later Advances in the PPSA ................................................................................................ 46 Policy Justifications with Respect to Later Advances............................................................................... 46 EXCEPTIONS TO GENERAL FIRST TO PUBLISH/REGISTER RULE ...................................................................... 46 Purchase Money Super Priority ............................................................................................................... 46 a. b. Purchase Money Security Interest in the PPSA ............................................................................................ 47 Purchase Money Security Interest in the CCQ .............................................................................................. 47 i. Vendor’s Hypothec ....................................................................................................................................... 47 CCQ 2948 ............................................................................................................................................. 47 CCQ 2954 ............................................................................................................................................. 47 Maschinenfabrik Rieter (QCCA, 2005) .............................................................................................. 48 ii. Non-hypothecary Devices ........................................................................................................................... 48 iii. General .......................................................................................................................................................... 49 c. Policy Differences in Purchase Money Super Priority .................................................................................. 49 2. Serial Numbered Goods............................................................................................................................ 49 a. i. ii. iii. b. 3. Serial Numbered Goods in the PPSA ............................................................................................................. 49 Equipment ..................................................................................................................................................... 49 Consumer Goods ......................................................................................................................................... 50 Inventory ........................................................................................................................................................ 50 Serial Numbered Goods in the CCQ ............................................................................................................... 50 Voluntary Subordination of Priority Between Secured Creditors ............................................................ 50 a. b. c. d. Voluntary Subordination in the CCQ ............................................................................................................... 50 CCQ 2956 ............................................................................................................................................. 50 Voluntary Subordination in the PPSA ............................................................................................................. 50 Intercreditor Agreements .................................................................................................................................. 51 “Assigning” Priority............................................................................................................................................. 51 Innovation Credit Union (Sask. C.A., 2009) ...................................................................................... 52 Radius Credit Union (Sask. C.A., 2009) ............................................................................................. 53 VI. COMPETING CLAIMANTS: BUYERS ......................................................... 54 A. SECURED CREDITOR’S DROIT DE SUITE .......................................................................................................... 54 4 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH B. 1. 2. 3. EXCEPTIONS TO THE DROIT DE SUITE ............................................................................................................. 54 Failure to Publish/Perfect ........................................................................................................................ 54 Authorized Sales ....................................................................................................................................... 54 Sale in the Ordinary Course of Business .................................................................................................. 54 a. b. Sale in the Ordinary Course of Business in the PPSA ................................................................................. 54 Sale in the Ordinary Course of Business in the CCQ ................................................................................... 55 i. Hypothecs ...................................................................................................................................................... 55 ii. Non-hypothecary Security ........................................................................................................................... 55 CCQ 1713 ............................................................................................................................................. 55 CCQ 1714 ............................................................................................................................................. 55 c. Remedies for Sale in the Ordinary Course of Business ............................................................................... 55 4. 5. Serial Numbered Goods............................................................................................................................ 56 Low Value Goods ..................................................................................................................................... 56 VII.COMPETING CLAIMANTS: UNSECURED CREDITORS AND NONCONSENSUAL SECURED CREDITORS ......................................................... 56 A. 1. PRIOR CLAIMS AND LEGAL HYPOTHECS ........................................................................................................ 56 Prior Claims ............................................................................................................................................. 56 2. Legal Hypothecs ....................................................................................................................................... 57 CCQ 2651 ............................................................................................................................................. 56 CCQ 2724 ............................................................................................................................................. 57 B. C. JUDGMENT CREDITORS IN THE PPSA ............................................................................................................. 58 SPECIAL PRIORITY RULES FOR CONSTRUCTION SUPPLIERS ............................................................................ 59 1. Construction Suppliers’ Priority in the CCQ ........................................................................................... 59 2. Construction Suppliers’ Priority in the Common Law ............................................................................. 59 D. IMPACT OF FEDERAL BANKRUPTCY LEGISLATION ON PRIORITIES ................................................................. 59 VIII. ENFORCEMENT OF SECURITY ON DEFAULT ............................. 62 THE CREDITOR EXERCISES ENFORCEMENT MEASURES WHEN THE DEBTOR IS IN DEFAULT. THE DEFAULT MAY OCCUR BY VIRTUE OF BANKRUPTCY, OR IT MAY BE A DEFAULT TO ONE CREDITOR. ............................................................. 62 THE UNSECURED CREDITOR IS OWED A PERSONAL OBLIGATION, WHILE THE SECURED CREDITOR ACTUALLY HAS A PROPRIETARY RIGHT. BECAUSE OF THIS, THE LAW TRIES TO ENSURE THAT THE ENFORCEMENT OPTIONS AVAILABLE TO A SECURED CREDITOR ARE EFFICIENT. THERE ARE ALSO SAFEGUARDS AGAINST APPROPRIATE OF EXCESS VALUE BY THE SECURED CREDITOR. THE SECURED CREDITOR IS NOT ENTITLED TO THE ASSET ITSELF, BUT TO ITS VALUE. 62 a. Enforcement in the CCQ ................................................................................................................................... 62 THE CCQ ALLOWS CREDITORS TO EXERCISE THEIR PERSONAL AND HYPOTHECARY RIGHTS AGAINST THE DEBTOR IN CCQ 2748. THE CREDITOR MAY ONLY EXERCISE HIS HYPOTHECARY RIGHTS IN ADDITION TO HIS PERSONAL ONES; HE MAY NOT ADD MORE RIGHTS THROUGH THE SECURITY AGREEMENT................................................................... 62 ON ITS FACE, ENFORCEMENT IN CHAPTER V OF BOOK VI OF THE CCQ ONLY APPLIES TO HYPOTHECARY CREDITORS. HOWEVER, RECALL THAT THE TITLE-BASED SECURITY DEVICES ASSIMILATE THE HYPOTHECARY ENFORCEMENT MECHANISMS (EG, INSTALMENT SALES, SALES WITH THE RIGHT OF REDEMPTION, TRUSTS). THERE IS NO ENFORCEMENT ASSIMILATION FOR LEASES/LEASING; THEY MUST BE PUBLISHED FOR THIRD PARTY EFFECTIVENESS, BUT THE LESSOR’S REMEDIES ARE NOT THOSE OF A HYPOTHECARY CREDITOR. THIS CREATES A LOOPHOLE, BECAUSE SOMEONE COULD SET UP AN INSTALMENT SALE AS A LEASE TO TRY AND AVOID THE HYPOTHECARY ENFORCEMENT MECHANISM. ........................................................................................................... 62 b. Enforcement in the PPSA ................................................................................................................................. 62 THE PPSA IS FUNCTIONAL, AND APPLIES TO ALL TRANSACTIONS THAT CREATE A SECURITY RIGHT, IRRESPECTIVE OF FORM. HOWEVER, RECALL THAT CERTAIN TRANSACTIONS ARE DEEMED TO CREATE A SECURITY INTEREST WHEN THEY DO NOT ACTUALLY DO SO (EG, OPERATING LEASE FOR A TERM OF GREATER THAN ONE YEAR, COMMERCIAL CONSIGNMENT, ETC). THESE ARE NONETHELESS INCLUDED IN THE PPSA FOR PUBLICITY REASONS. THE PPSA’S ENFORCEMENT MEASURES (PART V) DO NOT APPLY TO DEEMED SECURITY TRANSACTIONS. .................................. 62 A. PRELIMINARY REMEDIES ............................................................................................................................... 63 1. Surrender/Seizure ..................................................................................................................................... 63 a. b. 2. Surrender in the CCQ ....................................................................................................................................... 63 Seizure in the PPSA .......................................................................................................................................... 63 Sale ........................................................................................................................................................... 63 a. Sale in the CCQ ................................................................................................................................................. 63 5 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH b. 3. 4. a. b. 5. Receivership in the Common Law................................................................................................................... 66 Administration of the Property of Another in the Civil Law ........................................................................... 66 RIGHTS OF GRANTOR AND THIRD PARTIES .................................................................................................... 67 1. Advance Notice ......................................................................................................................................... 67 The grantor and third parties have the right to advance notice of enforcement action. This enables them to monitor the enforcement proceeding to ensure their interests are protected. There is a risk that advanced notice will prompt the grantor to hide/secrete the asset. If the items are perishable, too much advanced notice might mean the items are valueless by the time the secured creditor gets them. ............................................... 67 The advanced notice requirement is closely linked to the grantor’s right of redemption: his right to recover the asset by paying the secured creditor. Giving the grantor this last chance to reclaim title is a very important element of the advanced notice requirement. ..................................................................................................... 67 a. b. C. Collection of Claims in the CCQ ...................................................................................................................... 65 Collection of Claims in the PPSA .................................................................................................................... 66 Receivership and Administration of the Property of Another ................................................................... 66 a. b. B. Sale in the PPSA ............................................................................................................................................... 64 Taking in Payment .................................................................................................................................... 65 Collection of Accounts .............................................................................................................................. 65 Advance Notice in the CCQ ............................................................................................................................. 67 Advance Notice in the PPSA............................................................................................................................ 67 IMPACT OF BANKRUPTCY/INSOLVENCY ON ENFORCEMENT RIGHTS .............................................................. 68 IX. CONFLICT OF LAWS ................................................................................... 68 6 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH I. INTRODUCTION AND OVERVIEW 1. Moveable and Immovable Security Interests Rules in the CCQ are in some sense extremely comprehensive: cover rules for both movables and immovables Framework for mortgage law for immovable assets in CML provinces is pretty scattered – have to go to registration acts as well as mortgage acts for each province Law on immovable security is far more simple than for movables: Number of rights is usually straightforward Registration system is pretty straightforward Don’t have immovables moving from one jurisdiction to another In today’s world, movable hypotheques are more common – more money is involved in them (though not for the individual consumer) 2. Federal/Provincial Issues Though we think of secured transactions as a provincial responsibility, which it is, there is also a federal component: Federal Bank Act and Bankruptcy and Insolvency Act (plus ships, railway cars, IP) Juxtaposition of two regimes creates problems – two sets of rights and responsibilities for banks – but no movement has happened on proposals to change this Problem: because of constitutional limitations, provinces are incapable of repairing gaps and problems created by imperfect federal statutes II. FORMAL AND FUNCTIONAL CONCEPTS OF SECURITY A. Consensual and Non-Consensual Concepts of Security 1. Consensual and Non-Consensual Security in the CCQ Drafters of the code attempted to assimilate the rules applying to hypothecs at two levels: Publication (applies to all the deemed hypothecs listed above) Enforcement: rules about how the creditor can seize the property CCQ PUBLICATION: Requirement that the creditor publish the security Hypothec Sale with a right of redemption Yes Yes (for road vehicles or other property determined by regulation) Yes Yes Security trust Installment sale ENFORCEMENT: Requirement that the creditor has to observe the rules that apply to the hypothecary rules when seizing assets Yes Yes (but some ambiguity) Yes Yes 7 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH Lease Leasing Yes Yes CCQ 2664 No No Hypothecation may take place only on the conditions and according to the formalities authorized by law. A hypothec may be conventional or legal. Conventional hypothecs are consensual (eg, I grant a creditor a hypothec via K). Legal hypothecs are non-consensual (eg, if I fail to pay my mechanic for repairs to my motorcycle, he may claim a legal hypothec [it is a non-consensual hypothec, because our agreement was for repair, not for a security interest]). The CCQ hypothecary rules encompass conventional and legal hypothecs, unless there is a stipulation. 2. Consensual and Non-Consensual Security in the Common Law PPSA “Security Interest” This includes any consensual transaction, regardless of form, and regardless of who has ownership of the asset, that has the function of providing security Transactions which aren’t meant to secure performance of an obligation (leases of more than a year, consignment, sales where possession doesn’t change, assignments) PUBLICATION: Requirement that the creditor publish the security Yes ENFORCEMENT: Requirement that the creditor must observe the rules that apply to the security interests when seizing assets Yes Yes No The PPSA applies only to consensual security rights. Although there is no specific exclusion, the Act as a whole makes this clear by requiring evidence of the agreement. The common law grants a right of retention to repairers (repairer’s lien). Under the Repairer’s and Storer’s Lien Act, repairers now have the right to dispose as well as retain. However, traditionally the right of retention does not include the right of disposal; it is limited to retention pending payment of the bill. As such, the right of retention is a personal right, not a security right. A security right is a form of property right over the asset itself. This is why it forms an alternate source of payment. B. Hypothecary and Title-Based Concepts of Security 1. Concepts of Security in the CCQ The CCQ’s principal form of security is the hypothec, particularly for immovables. The CCQ recognizes a multiplicity of security devices with respect to movables, including the hypothec and title-based forms of security: sale with a right of redemption, trust, instalment sale, and leasing. 8 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH a. Hypothec Requirement to publish: YES Requirement that the creditor must observe the rules that apply to the hypothecs when seizing assets: YES As per CCQ 2660, the Code’s principal form of security is the hypothec. However, in looking at security under Quebec law, can’t limit yourself to the book on hypotheques – also have to look at the law of sale and trust CCQ 2660 A hypothec is a real right on a movable or immovable property made liable for the performance of an obligation. It confers on the creditor the right to follow the property into whosever hands it may be, to take possession of it or to take it in payment, or to sell it or cause it to be sold and, in that case, to have a preference upon the proceeds of the sale ranking as determined in this Code. The advantages of holding a hypothec include (i) droit de suite (hypothec is a real right) (ii) right to enforce the interest against the collateral in cases of default: specialized remedies 1. possession 2. taking in payment (only with consent of grantor [unjust enrichment issue see Section VIII. Enforcement] 3. selling/causing to be sold 4. application of proceeds in satisfaction of the obligation (iii) preferential priority over unsecured creditors In a hypothec, the grantor remains the owner. Civil Code recognizes other institutions, beyond the hypotheque, that where title can also be used as security OUTSIDE the rules of hypotheques. b. Sale with the Right of Redemption Requirement to publish: YES (for road vehicles or other property determined by regulation) Requirement that the creditor must observe the rules that apply to the hypothecs when seizing assets: YES (with some ambiguity) In a sale with the right of redemption, the seller retains the right to have the ownership returned to him, upon fulfilment of the condition set forth in the agreement. This is defined at CCQ 1750. CCQ 1750 A sale with the right of redemption is a sale under a resolutory condition by which the seller transfers ownership of property to the buyer while reserving the right to redeem it. A right of redemption in respect of a road vehicle or other movable property determined by regulation, or in respect of any movable property acquired for the service or operation of an enterprise, has effect against third persons only if it has been published; effect against third persons operates from the date of the sale provided the right of redemption is published within fifteen days. As well, the transfer of such a right of redemption has effect against third persons only if it has been published. 9 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH Borrower transfers title in a piece of property to the creditor No mention of delivery of possession As per CCQ 1756, a sale with the right of redemption can also function as a security device (ie, it creates a real right to secure an obligation). Where this is the case, the seller is the borrower, and the buyer is the secured creditor. CCQ 1756 Where the object of the right of redemption is to secure a loan, the seller is deemed to be a borrower and the acquirer is deemed to be a hypothecary creditor. The seller does not, however, lose the right to exercise his right of redemption unless the acquirer follows the rules respecting the exercise of hypothecary rights laid down in the Book on Prior Claims and Hypothecs. Note that although the applicable provisions are located in the Chapter on Sales, the buyer is nonetheless governed by the hypothecary enforcement rules (ie, repayment of surplus value). A sale with the right of redemption is therefore a real sale in form, but a hypothec in function. By linking to the hypothecary enforcement rules, the CCQ protects sellers against losing the entire value of their asset, when all they originally wanted was a loan. In a sale with the right of redemption, the buyer (creditor) becomes the owner. c. Security Trust Requirement to publish: YES Requirement that the creditor must observe the rules that apply to the hypothecs when seizing assets: YES An onerous trust (commercial trust) may also function as a security device, as per CCQ 1263. CCQ 1263 The purpose of an onerous trust established by contract may be to secure the performance of an obligation. If that is the case, to have effect against third persons, the trust must be published in the register of personal and movable real rights or in the land register, according to the movable or immovable nature of the property transferred in trust. In case of default by the settlor, the trustee is governed by the rules regarding the exercise of hypothecary rights set out in the Book on Prior Claims and Hypothecs. The settlor is the grantor, and the trustee is the secured creditor. Like a sale with the right of redemption, an onerous trust functions like a security device. The trustee (creditor) becomes the owner. d. Instalment Sale Requirement to publish: YES Requirement that the creditor must observe the rules that apply to the hypothecs when seizing assets: YES In the hypothec, sale with the right of redemption, and onerous trust, the grantor is the owner prior to the parties entering into the credit arrangement. An instalment sale is the reverse situation: the prior owner is the creditor, not the grantor. As per CCQ 1745, the seller is the creditor, and the buyer is the grantor (ie, the seller retains title; if the buyer fails to pay the full price, the seller takes back the item). 10 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH CCQ 1745 An instalment sale is a term sale by which the seller reserves ownership of the property until full payment of the sale price. A reservation of ownership in respect of a road vehicle or other movable property determined by regulation, or in respect of any movable property acquired for the service or operation of an enterprise, has effect against third persons only if it has been published; effect against third persons operates from the date of the sale provided the reservation of ownership is published within fifteen days. As well, the transfer of such a reservation has effect against third persons only if it has been published. As per CCQ 1749, instalment sales are linked to the hypothecary enforcement rules. This raises a surplus value issue, in that the seller is entitled to take back the item and appropriate any money already paid. However, the functional similarity to a hypothec “overrides” this, leading to the cross-reference. CCQ 1749 e. A seller or transferee who, upon the default of the buyer, elects to take back the property sold is governed by the rules regarding the exercise of hypothecary rights set out in the Book on Prior Claims and Hypothecs; however, in the case of a consumer contract, only the rules contained in the Consumer Protection Act are applicable to the exercise by the seller or transferee of the right of repossession…. Leasing Requirement to publish: YES Requirement that the creditor must observe the rules that apply to the hypothecs when seizing assets: NO Leasing is defined at CCQ 1842: Refers to movable property placed at the disposal of the lessee by the lessor, for a fixed term in return for payment. Usually, bank buys asset from supplier identified by the lessee, then leases asset to lessee. CCQ 1842 Leasing is a contract by which a person, the lessor, puts movable property at the disposal of another person, the lessee, for a fixed term and in return for payment. The lessor acquires the property that is the subject of the leasing from a third party at the demand and in accordance with the instructions of the lessee. Leasing may be entered into for business purposes only. Leasing can function as a security device, in that it resembles an instalment sale (eg, I lease computer equipment for three years, at the end of which time it will be obsolete and useless; the money I pay every month is similar to what a seller would charge under an instalment sale, where ownership would transfer at the end of the three years). However, leasing is not explicitly cross-referenced to the hypothecary enforcement rules. Although CCQ 1847 mandates registration for third party effectiveness, the available remedies are those of a lessor, not a hypothecary creditor. CCQ 1847 The rights of ownership of the lessor have effect against third persons only if they have been published; effect against third persons operates from the date of the leasing contract provided the rights are published within fifteen days. As well, the transfer of the lessor’s rights of ownership has effect against third persons only if it has been published. 11 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH 2. Concepts of Security in the PPSA a. Security Interest (Comprehensive) The PPSAs adopt a functional concept of security. If the purpose of a transaction is to create a security interest, then the PPSA applies, regardless of who actually holds title. Disadvantages: Less certain than the CCQ approach, Advantages: Don’t have a fragmented system, where part of the law of secured transactions lies outside secured transactions as such Mitigates the risk of people avoiding the applicable laws on secured transactions. The PPSAs apply only to movables, and are restricted to consensual security rights. The definition of “security interest” in s.1 must be read in tandem with the scope provision (NB s.3.1, ON s. 2a). A security interest is an interest in personal property that secures payment or performance of an obligation. The interest is in a real right; it is proprietary, not contractual. ON PPSA 1 (definitions) “security interest” means an interest in personal property that secures payment or performance of an obligation, and includes, whether or not the interest secures payment or performance of an obligation, (a) the interest of a transferee of an account or chattel paper, and (b) the interest of a lessor of goods under a lease for a term of more than one year; (“sûreté”) Subject to subsection 4(1), this Act applies to, ON PPSA 2(a) (a) every transaction without regard to its form and without regard to the person who has title to the collateral that in substance creates a security interest including, without limiting the foregoing, (i) a chattel mortgage, conditional sale, equipment trust, debenture, floating charge, pledge, trust indenture or trust receipt, and (ii) an assignment, lease or consignment that secures payment or performance of an obligation; Things that don’t count as security interests: Negative pledge agreements do not create a security interest, because they do not create a proprietary right; they are merely a contractual undertaking not to grant security to another. Set-offs also do not create a security interest, because the right of set-off is an implied term of the banking K. The bank has no security interest in the moneys it owes me; I can transfer my right to claim to a third party, but not to the bank with whom I already have a lending relationship. 12 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH Things that do count as security interests: 1. Sales with the right of redemption o A proprietary right is being created to secure the performance of an obligation. Remember, it is irrelevant where title actually lies. 2. Conditional sales (ie, instalment sales) o Explicitly included in ON s. 2a(i). o Without this express stipulation, one might argue that the PPSA should not apply, because no new right is being created in favour of the secured creditor. There is merely the refusal to relinquish existing title. However, the purpose of the refusal is to secure the performance of an obligation. o These are different from situations where the creditor GETS title from the debtor E.g. a mortgage, where the buyer (debtor) transfers title of the house to the bank o If you do this kind of installment sale, as a creditor, your interest is reduced from ownership to a security interest The common law didn’t treat it this way – CML treated it like CVL – this is a conscious legislative innovation In England, this approach still applies 3. Assignments (universal to all PPSAs) 4. Lease (see above) (universal to all PPSAs) 5. Sale without a change of possession o As above, another problem with ostensible ownership – need to protect the second buyer from buying from the non-owner 6. Consignment (universal to all PPSAs except Ontario) o Common in the art world o Essentially the owner of the gallery acts as the artists agent for sale and keeps a portion of the profits o Needs to be registered: otherwise, if the gallery owner has some of his own principle and some stuff he’s selling for artists on consignment, and he wants to use it as security to borrow money, how is the lender supposed to know how much of the inventory is his? o Doesn’t apply in situations where “everybody knows” that the assets don’t belong to the seller (e.g. auctioneers) o Also doesn’t apply to non-professional consignment sales (e.g. getting your sister to sell your car for you C. Transactions “Deemed” to be Secured Transactions Certain transactions are not secured transactions, but share similar policy concerns. For this reason, they are “deemed” secured transactions and are captured by the relevant CCQ provisions and PPSAs. 1. Assignments a. Assignments in the CCQ An assignment is the sale of the right to collect a debt to another party (eg, “transfer of an account”). CCQ 1642 The assignment of a universality of claims, present or future, may be set up against debtors and third persons by the registration of the assignment in the register of personal and movable real rights, provided, however, that the 13 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH other formalities whereby the assignment may be set up against the debtors who have not acquiesced in it have been accomplished. Like the PPSA, registration is a pre-condition to third party effectiveness. Note that assignment of claims refers to a universality of claims (as opposed to specified debts/debtors). Specific assignments do not have to be registered. Contrast this with hypothecs: if I grant a hypothec on claims owing to me (rather than assigning them), I must register the hypothec whether the claims are specific or a universality. This creates a flaw: if I am a bank taking a hypothec, I don’t know whether certain things have been assigned or not, and my hypothec diminishes in value. b. Assignments in the PPSA An assignment does not create a security interest as such; it is a purchase agreement, and should be governed by the law of sale. However, it falls within the PPSA (ON s. 2(b), NB s. 3(2)). …this Act applies to… ON PPSA 2(b) NB: (b) a transfer of an account or chattel paper even through the transfer may not secure payment or performance of an obligation; The only difference between accounts and chattel paper is that the latter is an account secured by a security right in specific goods. Why is this in the PPSA? Because of the first to register rule. One of the major policy objectives of the PPSA is the requirement of public registration to perfect a security right: the first to register gets priority, irrespective of when the transaction actually occurred. By subjecting assignments to the first to register rule, banks can verify whether accounts have already been assigned, thus preventing people from double-financing their assets. This also protects the other assignees by allowing them to verify too. The PPSA’s enforcement chapter does not apply to assignments. This is because the enforcement provisions are intended to protect the residual interest of the borrower (ie, borrower gets the surplus value back). Here, the account is being sold; there is no residual interest. Assignments commonly feature in factoring, which is essentially asset-based financing: I buy accounts receivable, and advance money thereon. I am relying on the value of the asset rather than the credit risk of the borrower. Assets also feature in securitization, which is the transformation of monetary obligations into an investment instrument. The accounts receivable of Company X are assigned to a Special Purpose Vehicle The SPV issues securities on these accounts receivable o (Securities can be Grade A, B, C, based on the likelihood of repayment) Investors are reassured o Even if X becomes insolvent, the SPV can go after the borrower directly. o The insolvency risk is insulated; my investment is not really in X, but X’s customers, and the risk of default is spread amongst all of them. 14 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH 2. Operating Leases a. Leases and Leasing in the CCQ The CCQ applies to both leasing (discussed above) and leases. Leasing: lessor serves as a middleman between owner and lessee (?) Lease: owner leases directly to lessee (?) As per CCQ 1851, a lease is a contractual arrangement between the lessor and lessee, whereby the former provides the latter with the enjoyment of a movable or immovable, in exchange for rent, for a certain period of time. CCQ 1851 Lease is a contract by which a person, the lessor, undertakes to provide another person, the lessee, in return for a rent, with the enjoyment of a movable or immovable property for a certain time. The term of a lease is fixed or indeterminate. Just like leasing, leases with a term greater than one year are subject to the registration requirement as per CCQ 1852. The rights resulting from the lease may be published. CCQ 1852 Publication is required, however, in the case of rights under a lease with a term of more than one year in respect of a road vehicle or other movable property determined by regulation, or of any movable property required for the service or operation of an enterprise, subject, in the latter case, to regulatory exclusions… The CCQ does not distinguish between a financial lease and an operating lease with a term of greater than one year, unlike the PPSA. b. Operating Leases in the PPSA The PPSA does distinguish between a financial lease and an operating lease with a term of greater than one year, unlike the CCQ. An operating lease is a lease whose actual purpose is to give the lessee enjoyment of the leased thing o This only falls within the PPSA if the lease is for a term greater than one year (ON 2(c), NB 3(2)). Financial leases are included in the PPSAs as leases that “secure payment or performance of an obligation” (ON 2(a)(ii), NB 3(1)(b)). o These fall within the PPSA no matter what the length of the term …this Act applies to… ON PPSA 2(c) (c) a lease of goods under a lease for a term of more than one year even though the lease may not secure payment or performance of an obligation. The PPSA enforcement provisions do not apply. 15 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH The reason this falls under the PPSA is again related to registration. A third party has no way of knowing whether the lessee’s possession is because of ownership, or because he is a bailee. By making operating leases subject to the first to register rule, secured creditors can ascertain whether there is already ownership (ie, whether there’s already a proprietary right). PPSA only uses the term “lease”, which encompasses the concepts of both “lease” and “leasing” under the CCQ 3. Consignments Consignments are a contractual arrangement between the consignor and the consignee to sell goods on an agency basis. Title goes directly from the consignor to the buyer Often used in the art world: art gallery = consignee; artist = consignor The consignee is simply the consignor (owner’s) agent, selling the goods on his behalf. This is substantially an instalment sale: the consignor retains title, the consignee pays the consignor up front, and the consignor takes back the goods if the consignee cannot sell them. Generally need to be registered: o Otherwise, if the gallery owner has some of his own principle and some stuff he’s selling for artists on consignment, and he wants to use it as security to borrow money, how is the lender supposed to know how much of the inventory is his? Registration not necessary (see definition of “commercial consignment” in s. 1 of the NB PPSA: o In situations where “everybody knows” that the assets don’t belong to the seller (e.g. auctioneers) o For non-professional consignment sales (e.g. getting your sister to sell your car for you) The ON PPSA does not apply to commercial consignments. All of the other PPSAs do apply to commercial consignments, even ones that are not intended to secure performance of an obligation, but merely function as “true” consignments. Subject to sections 4 and 55, this Act applies NB PPSA 3(2)(a) (a) to a commercial consignment… that does not secure payment or performance of an obligation. 4. Sale of Goods Without a Change of Possession This refers to a situation where a seller sells goods to a buyer such that title passes, but the seller retains possession. This is only covered by the PPSAs of the Atlantic provinces. …this Act applies… NB PPSA 3(2)(d) (d) to a sale of goods without a change of possession, that does not secure payment or performance of an obligation. Again, the reason for inclusion is related to registration. Third parties might assume that your possession of the good is due to ownership, and not realize that title has passed. By making these sales subject to registration, third party interests are protected. 16 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH II. CREATION OF (CONSENSUAL) SECURITY RIGHTS Note: creation is the first step – refers to creation of security rights between the grantor and the secured creditor The next step (at III, below) is publication/perfection – refers to the secured creditor’s rights as against third parties A. General Considerations Creation/attachment, publication, and priority are independent but related concepts. Rules around creation/attachment o Required to order the inter-party relationship Rules around publication/perfection o Required for third-party effectiveness In both the CCQ and PPSAs, there are separate sets of rules that (i) make the security interest binding on the debtor and creditor, and; (ii) make the security interest effective against third parties, and; (iii) govern priority between creditors. All three sets of rules must work in conjunction with one another I.e. one cannot register an interest that was not validly created; one cannot benefit from priority without first showing creation and third party effectiveness Remember that the general law of contract still applies to security (e.g. can still be vitiated for fraud, mistake, etc.) (but we don’t need to know it for the exam) Remember also that the rules of property apply B. Granting Security to Secure the Obligation of a Third Person It is possible to grant security in one’s assets to secure the obligation of a third party E.g. I am the principal shareholder of a start-up, and my start-up requires financing o I can obtain financing by granting a security interest in my personal assets to secure my start-up’s obligations Note that instalment sales cannot be used to secure third party obligations, because the creation of the security interest is only to fulfil the purchase price. The financing is creditor-based, not asset-based. 1. Securing the Obligations of a Third Person in the CCQ The CCQ grants explicit permission. As per CCQ 2681, the hypothec may be granted by the actual debtor, or by a third party (2861, par. 2) First paragraph of 2681 contemplates that only a person capable of alienating property can grant a hypothec in it Statement of nemo dat principle: can’t give more than you have CCQ 2681 A conventional hypothec may be granted only by a person having the capacity to alienate the property hypothecated. 17 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH It may be granted by the debtor of the obligation secured or by a third person. 2. Securing the Obligations of a Third Person in the PPSA The PPSA grants implicit permission. “Debtor” is defined in s. 1 as the person who owes payment or performance, or the owner of the collateral (ON s. 1(1), NB s. 1). The PPSA thus assumes that the person who owes the obligation might not be the person who grants the security interest. ON PPSA 1(1) “debtor” means, (b) if the person who owes payment or other performance of the obligation secured and the person who owns or has rights in the collateral are not the same person, (i) in a provision dealing with the obligation secured, the person who owes payment or other performance of the obligation secured, (ii) in a provision dealing with collateral, the person who owns or has rights in the collateral, including a transferee of or successor to a debtor’s interest in collateral, C. Permissible Parties To what extent should a natural person be allowed to grant a hypothec without delivery? One end of the spectrum: PPSA o Should be allowed to place a hypothec on everything, present and future, in principle o Then, imposed certain restrictions – things that can’t be securitized: Growing crops that will be harvested more than one year later After-acquired consumer goods Goods acquired primarily for personal, family, or household purposes Other end of the spectrum: CCQ o Start with the principle that a natural person shouldn’t be allowed to grant security in any of their personal goods without delivery o Then, allowed certain exceptions (see above) Now, there is only a small space of difference between the CCQ and the PPSA: they are converging in terms of how much paternalism they want to build into the legislation 1. Permissible Parties in the CCQ The CCQ does not limit who may take security (the grantee). But it does impose limitations on who may grant security. These limitations may be found in CCQ 2681-2686 in the Chapter on Conventional Hypothecs. 18 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH The most important are the restrictions on the ability of natural persons to grant a hypothec without delivery (2683) CCQ 2683 Except where he operates an enterprise and the hypothec is charged on the property of that enterprise, a natural person may grant a movable hypothec without delivery only on road vehicles or other movable property determined by regulation and subject to the conditions determined by regulation [see r. 5 below]. Where the act constituting the hypothec is accessory to a consumer contract, it is subject to the rules as to form and contents prescribed by this Book or by regulations. CCQ R. 5 Regulation respecting the register of personal and movable real rights Art. 15.02 The property on which a natural person who does not operate an enterprise may grant a movable hypothec without delivery pursuant to article 2683 of the Civil Code is Art. 15.01 (1) the property listed in section 15.01; (2) precious property within the meaning of the Taxation Act (3) incorporeal property, particularly property that constitutes a form of investment within the meaning of the Securities Act (R.S.Q., c. V-1.1), securities and security entitlements referred to in the Act respecting the transfer of securities and the establishment of security entitlements (R.S.Q., c. T-11.002), derivatives referred to in the Derivatives Act (R.S.Q., c. I-14.01), claims, rights arising from an insurance contract and intellectual property rights, excluding in all cases property constituting a registered retirement savings plan, a registered retirement income fund, a registered education savings plan or a registered disability savings plan within the meaning of the Taxation Act. (1) a road vehicle included in one of the classes referred to in subparagraphs 1, 2, 9, 10 and 11 of the first paragraph of section 15; (2) a caravan or a fifth-wheel; (3) a mobile home; (4) a boat; (5) a personal watercraft; (6) an aircraft. 19 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH So, as a natural person, what can I grant a hypothec on without delivery? 1. Assets of an enterprise 2. Road vehicles 3. Other movable property determined by regulation: o This addition was a response to the criticism that the legislation is too restrictive – SCC said the code should be more like the PPSA o What’s included? Things like paintings, jewelry, luxury items, etc. Kind of absurd to say that you could grant security to a pawn-broker (who tend to charge very high interest), but not to a bank, who wouldn’t require that you deliver it over Also incorporeal property Investment assets Bank accounts (right to be paid the money owed to you by a bank) Insurance policy o What’s excluded? Registered retirement savings plans Education savings plans Disability pensions Of course, if I want to deliver the asset, I can grant a security interest in anything Thus, I can pawn anything, because pawning involves delivering the asset This limitation is not extended to title-based security devices: That is, doesn’t apply to: o Sales with the right of redemption o Instalment sales o Leasing A two-party lease is possible, notwithstanding the stipulation in CCQ 1842 that leasing may only be entered into for business purposes). Why did the legislature want to impose these restrictions on the degree to which a natural person can securitize their stuff? Paternalistic purpose: don’t want people to securitize their entire future income, for example What is the justification for limiting the hypothecary ability of natural persons, especially when the limitation does not extend to non-hypothecary forms of security? A hypothec may refer to a universality of assets (present and future), while the non-hypothecary devices are necessarily limited to specific assets. The limitation aims to prevent people from granting blanket security on all of their assets. However, this concern is specifically addressed at CCQ 2684, which stipulates that only businesses can grant a hypothec on a universality. CCQ 2684 Only a person or a trustee carrying on an enterprise may grant a hypothec on a universality of property, movable or immovable, present or future, corporeal or incorporeal… Both provisions raise the question of the extent to which the law should protect people from themselves. Is CCQ 2684 necessary, given the restriction already imposed by CCQ 2683? 20 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH 2. Permissible Parties in the PPSA The PPSA does not impose explicit restrictions on the grantor or grantee. It does, however, impose some restrictions on a grantor’s ability to grant a security interest in after-acquired property. This is a narrower restriction than that imposed by the CCQ. NB PPSA s. 13 After-acquired property 12.1 A security agreement may cover after-acquired property. Exception (2) No security interest attaches under an after-acquired property clause in a security agreement, a) to crops that become such more than one year after the security agreement has been executed, except that a security interest in crops that is given in conjunction with a lease, purchase or mortgage of land may, if so agreed, attach to crops to be grown on the land concerned during the term of such lease, purchase or mortgage; or b) to consumer goods, other than accessions, unless the debtor acquires rights in them within ten days after the secured party gives value. R.S.O. 1990, c. P.10, s. 12. C. Exempt Assets Both the CCQ and PPSA exempt certain assets from seizure by creditors. The exemptions seek to preserve a minimum level of economic viability; the Legislature does not want people to become a charge on society. 1. Exempt Assets in the CCQ As per CCQ 2268, property exempt from seizure may not be hypothecated. CCQ 2668 Property exempt from seizure may not be hypothecated. The same rule applies to movable property belonging to a debtor which furnishes his main residence and which is used by and is necessary for the life of the household. 2. Exempt Assets in the PPSA The PPSAs do not restrict the ability to grant security on exempt goods; but if security is granted, the property cannot be seized by creditors. The reason for the different approach is because the exemptions are articulated in terms of their monetary value (ie, the collateral is exempt only to the level appropriate for me, the bad debtor). NB PPSA 58(3) Subject to subsection 7, a debtor may claim the following items of collateral to be exempt from seizure by a secured party: 21 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH (a) furniture, household furnishings and appliances used by the debtor or a dependant to a realizable value of five thousand dollars or to any grater amount that may be prescribed; (b) one motor vehicle having a realizable value of not more than six thousand five hundred dollars at the time the claim for exemption is made… In the NB PPSA (58(7)), there is an exceptions to the exemptions: the exemptions don’t apply, for example, where I borrow money in order to buy a car, and then default – can’t claim an exemption for the car D. Requirements for Creation/Attachment of Security Rights In brief: 1. Existence of a secured obligation o Value must be given by the secured creditor 2. Grantor’s rights in the asset o Nemo dat: can’t give anyone a greater right in the property than you have yourself 3. Evidence of security interest For the Ont. PPSA, set out entirely in s. 11(2) [s. 12(1) NB PPSA] ON PPSA 11 11 (1) A security interest is not enforceable against a third party unless it has attached. 11(2) Subject to section 11.1, a security interest, including a security interest in the nature of a floating charge, attaches to collateral only when value is given, the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party and, (a) the debtor has signed a security agreement that contains, (i) a description of the collateral sufficient to enable it to be identified, or (ii) a description of collateral that is a security entitlement, securities account or futures account, if it describes the collateral by any of those terms or as investment property or if it describes the underlying financial asset or futures contract; (b) the collateral is not a certificated security and is in the possession of the secured party or a person on behalf of the secured party other than the debtor or the debtor’s agent pursuant to the debtor’s security agreement; (c) the collateral is a certificated security in registered form and the security certificate has been delivered to the secured party under section 68 of the Securities Transfer Act, 2006 pursuant to the debtor’s security agreement; or (d) the collateral is investment property and the secured party has control under subsection 1 (2) pursuant to the debtor’s security agreement. 2006, c. 8, s. 129. 22 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH 1. Existence of Secured Obligation If there is no obligation owing, then there is no security right. a. Existence of Secured Obligation in CCQ CCQ 2661 articulates the accessory principle: CCQ 2661 A hypothec is merely an accessory right, and subsists only as long as the obligation whose performance is secures continues to exist. As per CCQ 2687, a hypothec may be used to secure any obligation. CCQ 2687 A hypothec may be granted to secure any obligation whatever. The accessory principle is one reason the civilian tradition dislikes the hypothecation of future assets (eg, a line of credit that is always fluctuating; if the balance reaches zero, there is no more underlying obligation). In response to this, CCQ 2688 deals explicitly with lines of credit, saying that the hypothec is still good even if only part of the value is advanced at any one time. CCQ 2688 A hypothec granted to secure payment of a sum of money is valid even if, when it is granted, the debtor has not received the prestation in consideration of which he has undertaken the obligation, or has received only part of it. The rule is applicable in particular to lines of credit and the issue of bonds or other titles of indebtedness. CCQ 2691 b. Where the creditor refuses to hand over the sums of money he has undertaken to lend and for which he holds a hypothec as security, the debtor or the grantor may, at the expense of the creditor, cause the hypothec to be reduced or cancelled, upon payment, in the latter case, of only the amounts that may then be due. Existence of Secured Obligation in PPSA The PPSA has no problem with future obligations. As per s. 1, “value” encompasses antecedent debts and liabilities. Value is defined as any consideration sufficient to support a contract – thus, a promise to give money is enough (don’t actually need to give the money yet for the security interest to be valid) The security interest attaches once value is given (ON s. 11(2), NB s. 12(1)(a)). ON PPSA 11(2) Subject to s. 11(1), a security interest, including a security interest in the nature of a floating charge, attaches to collateral only when value is given… 23 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH The PPSA explicitly permits future advances (ON s. 13, NB s. 14). A security agreement may secure future advances. ON PPSA 13 Under the PPSA, first to register priority extends to future advances. This makes it difficult for the grantor to access alternate sources of financing, because the residual value of the collateral may already be gone; subsequent secured creditors cannot confidently lend. CCQ is superior in this respect The PPSA allows subordination agreements, where the first secured creditor undertakes to limit his priority to a certain amount. On the one hand, the PPSA makes it difficult for grantors to access financing from subsequent secured creditors. On the other hand, the CCQ simply encourages a tendency to inflate the estimate of actual lending in order to cover the risk. 2. Grantor’s Right in Collateral The grantor must have a real right in the collateral in which they purport to grant security. a. Grantor’s Right in the CCQ Under CCQ 2666, a hypothec can be on any kind of collateral: corporeal or incorporeal, a universality or a specific asset. CCQ 2666 A hypothec is a charge on one or several specific corporeal or incorporeal properties, or on all the properties included in a universality. CCQ 2666 implies that future collateral (eg, future inventory) can also be hypothecated. Universality: everything within a universal category the way the parties have defined it (e.g. all business equipment) In other words, no need for specificity However, as per CCQ 2670, a hypothec on future property only affects the property when the grantor acquires title. CCQ 2670 A hypothec on the property of another or on future property begins to affect it only when the grantor acquires title to the hypothecated right. The CCQ thus enables grantors to enter agreements on the basis of property they don’t own, or that is not yet in existence (the PPSA enables the same thing; see below). Without this, commercial financing would be impossible. Grantors must be able to grant security in future assets, and on a universality, not just a specific asset. b. Grantor’s Right in the PPSA The PPSA stipulates that debtors must have a right in the collateral (ON 11(2), NB 12(1)(b)). ON PPSA 11(2) Subject to s. 11(1), a security interest, including a security interest in the nature of a floating charge, attaches to collateral only when value is 24 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH given, the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party and… Like the CCQ, the PPSA permits debtors to grant security on future assets (“after-acquired property”). A security agreement may cover after-acquired property. ON PPSA 12 The security right in after-acquired assets may be covered by the original security agreement (ie, the security agreement may cover present and after-acquired assets). There is no need for multiple security agreements. 3. Evidence of a security agreement Either a written security agreement … Must fulfill certain contract requirements o For real property securities, you absolutely need a written record (Statute of Frauds) o Of course, the creditor takes a risk if she chooses not to have a written agreement – can devolve into he said-she said …Or debtor delivers possession of the encumbered asset to the secured creditor a. Evidence of a security agreement in the CCQ Three requirements: 1. Same as PPSA: need either delivery or a written grant o Written grant: 2696. A movable hypothec without delivery shall, on pain of absolute nullity, be granted in writing. o Delivery: 2702. A movable hypothec with delivery is granted by physical delivery of the property or title to the creditor or, if the property is already in his hands, by his continuing to physically hold it, with the grantor's consent, to secure his claim. o 2692-2694: Set out the written requirements for security interests in immovables and in the rents generated from immovables (writing required) 2. Description o 2697. A sufficient description of the hypothecated property shall be contained in the act constituting a movable hypothec or, in the case of a universality of movables, an indication of the nature of that universality. 3. Need indication of the specific sum for which the hypothec is granted (not a requirement under the PPSAs!) o 2689. An act validly constituting a hypothec indicates the specific sum for which it is granted. If the creditor lends beyond the value of the hypothec, he is unsecured. However, the value of the hypothec does not have to equal the value of the underlying obligation. 2689 [para. 2]. The same rule applies even where the hypothec is constituted to secure the performance of an obligation of which the value cannot be determined or is uncertain. As per CCQ 2689, valid hypothecs must have a value (ie, the specific sum for which the hypothec is being granted). This is intended to cover a situation where the underlying obligation is to pay “all present and future loans.” It is impossible to determine the value of this obligation. 25 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH o Although the contractual language is flexible and reflects the intention of the parties to advance different amounts over time, the parties must specify a figure on the day they create the hypothec. Setting a maximum value on the hypothec is intended to protect the borrower, and ensure his access to alternative sources of financing for the excess value of the collateral E.g. if the collateral grows in value, beyond the maximum value of the hypothec already granted to SC1, the grantor can easily grant additional hypothec to subsequent SCs The subsequent SCs will be confident that there is sufficient value in the collateral to pay them). 2690. The sum for which the hypothec is granted is not considered to be indeterminate where the act, rather than stipulating a fixed rate of interest, contains the necessary particulars for determining the actual rate of interest on the obligation. The non-hypothecary security devices do not share the same formality requirements as hypothecs. But these devices all relate to specific assets, so description is not an issue. Recall CCQ 2683, which restricted the ability of natural persons to grant a movable hypothec without delivery. As per this article, if the hypothec is related to a consumer K, the consumer protection rules will also apply. These may impose additional formality requirements. b. Evidence of a security agreement in the PPSA The writing requirement in the PPSA is only necessary for third party enforceability. As between the debtor and secured creditor, a verbal security agreement is sufficient. See ON ss. 9 and 11 (1) and (2), NB ss. 9, 12(1)(c), 10(1). ON PPSA 9 Except as otherwise provided by this or any other Act, a security agreement is effective according to its terms between the parties to it and against third parties. ON PPSA 11 11 (1) A security interest is not enforceable against a third party unless it has attached. 11(2) Subject to section 11.1, a security interest, including a security interest in the nature of a floating charge, attaches to collateral only when value is given, the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party and, (a) the debtor has signed a security agreement that contains, (i) a description of the collateral sufficient to enable it to be identified, or (ii) a description of collateral that is a security entitlement, securities account or futures account, if it describes the collateral by any of those terms or as investment property or if it describes the underlying 26 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH financial asset or futures contract; (b) the collateral is not a certificated security and is in the possession of the secured party or a person on behalf of the secured party other than the debtor or the debtor’s agent pursuant to the debtor’s security agreement; (c) the collateral is a certificated security in registered form and the security certificate has been delivered to the secured party under section 68 of the Securities Transfer Act, 2006 pursuant to the debtor’s security agreement; or (d) the collateral is investment property and the secured party has control under subsection 1 (2) pursuant to the debtor’s security agreement. 2006, c. 8, s. 129. E. What Counts as Property for the Purposes of Attachment of Security Interests? Saulnier (SCC from Nova Scotia, 2008) – Binnie Facts: Fisherman granted a security interest in “all . . . present and after acquired personal property including . . . Intangibles” to a bank He then went bankrupt The trustee in bankruptcy and the bank tried to seize his fishing licenses; he objected Issue: Should his fishing licenses count as property such that the trustee in bankruptcy, acting under the BIA, or the bank, acting under the PPSA, should be able to take them? Holding: Yes: the licenses count as property under both definition in the PPSA (s. 2) and the BIA (also s. 2) Reasoning: A fishing license is definitely a commercial asset – offers much more to the holder than the right to do something that would otherwise be unlawful o Confers a right to engage in an exclusive activity o Confers a proprietary right in the fish harvested o Resembles a profit a prendre (Walsh disputes this), which is unquestionably a property right (Binnie admits that it isn’t a profit a prendre, though) While this doesn’t fully satisfy the definition of “property” at common law, they satisfy the definition for the purposes of the PPSA and the BIA Rejects “Traditional Property Approach”, “Regulatory Approach”, and “Commercial Value Approch” for looking at the property These are commercial instruments and should be interpreted as such Purposive interpretation: o BIA: Parliament unambiguously signalled an intention to sweep up a variety of assets of the bankrupt not normally considered “property” at common law, and this intention must be respected if the purposes of the BIA are to be achieved o PPSA: Definition of “intangible” in s. 2 of the PPSA includes an interest created by statute having the characteristics of a license coupled with an interest at common law – fits here 27 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH Caisse populaire Desjardins de l’Est de Drummond (SCC from Federal C.A., 2009) – Rothstein Facts: Caisse granted Camvrac a line of credit of up to $277,000 A week later, Camvrac deposited $200,000 with the Caisse in accordance with a “Term Savings Agreement”, according to which the deposit would be for a term of five years, and would be neither negotiable nor transferable o Camvrac entered a further “Security Given Through Savings” agreement with the Caisse not to remove the $200,000 as long as the line of credit was outstanding, and agreed that in the event of default there would be compensation (set-off) between the credit agreement and the term deposit Camvrac then went bankrupt Crown argues that the Caisse had a security interest in the $200,000 deposit o Thus, Crown argued that it should be able to collect Camvrac’s unpaid income taxes and employment insurance premiums should be deducted from the account, since property is held in trust for the Crown under s. 227(4.1) ITA and s. 86(2.1) EIA Caisse argues that it had no security interest – rather, the contractual right simply allowed it to extinguish its own indebtedness to Camvrac Issue: Does the $200,000 deposit count as the property of Camvrac subject to a security interest (such that the Crown can make deductions from it)? Holding: Yes Reasoning: Definition of “security interest” for the purposes of s. 224(1.3) of the ITA only imposes one condition: that the creditor’s interest in the debtor’s property secures payment or performance of an obligation o Doesn’t require that the agreement between creditor and debtor take any particular form o Parliament deliberately chose this expansive definition to facilitate collection of unpaid taxes Just because a contract provides for a right of compensation (set-off) doesn’t mean that it does not also involve a security interest – the key is looking at whether the parties intended to create a security interest, whatever the precise mechanism (such as set-off) the contract provides for realizing it In this case, the conditions of the five-year term and the maintenance and retention of the $200,000 deposit created the Caisse’s interest in Camvrac’s property for the purpse of s. 224(1.3) ITA o Without these encumbrances, there would have been no security interest o Thus, in ordinary situations where a customer borrows money from a bank, plus has an account at the bank with no limits on withdrawal etc., there would not be a security interest, since the bank does not have a continuous right in the property to protect itself against default Also, the vocabulary of the agreement (including the repeated use of the word “secure”) clearly show that a security agreement was contemplated NOTE: “the definition in s. 224(1.3) ITA is the only relevant definition of “security interest” for the purposes of s. 227(4.1) ITA and s. 86(2.1) EIA”, despite its similarity to terminology used in provincial statutes 28 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH III. THIRD PARTY EFFECTIVENESS (PUBLICATION/PERFECTION) Publication is the CCQ term, while perfection is used in the PPSA. A. Creation/Attachment, Perfection/Publication, and Priority Creation pertains to the rights created between the grantor and secured creditor. Perfection/publication pertains to the rights of the secured creditor against third parties; its objective is to ensure that third parties can learn of the security interest, and to provide an efficient means of ordering priorities between secured creditors. Priority pertains to the relative rank of secured creditors. B. Purposes of Perfection/Publication The purpose of perfection/publication is to protect third parties by enabling them to learn of the security interest. In order that prospective lenders know who is in place ahead of them In order that buyers know whether an asset is subject to a security right, and to adjust the price they are willing to pay accordingly In order to protect unsecured creditors o Otherwise, a debtor in trouble might decide to give security rights to “favoured” creditors (e.g. family members) down the line, leaving unsecured creditors out in the cold Perfection/publication is also related to priority, in that it provides an efficient means of ordering priority rank between secured creditors. The onus of perfecting/publishing is on the secured creditor. C. Consequences of Failure to Perfect/Publish 1. Failure to Publish in the CCQ As per CCQ 2663, hypothecs are opposable against third parties only when published. Without publication, there is no third party effectiveness. CCQ 2663 The hypothecary rights conferred by a hypothec may be set up against third persons only when the hypothec is published in accordance with this Book or the Book on Publication of Rights. Registration is the only mode of publication for hypothecs on immovables. Registration may also be a mode of publication for movable hypothecs. However, as per CCQ 2703, movable hypothecs may also be published by delivery. CCQ 2703 A movable hypothec with delivery is published by the creditor’s holding the property or title, and remains so only as long as he continues to hold it. For there to be third party effectiveness, one or the other mode of publication (i.e. registration in the appropriate registry, or delivery) must be adopted. This is made clear in CCQ 2934. 29 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH CCQ 2934 The publication of rights is effected by their registration in the register of personal and movable real rights or in the land register, unless some other mode is expressly permitted by law. Registration benefits the persons whose rights are thereby published. However, rights are effective as between the parties even before publication, as per CCQ 2941. CCQ 2941 Publication of rights allows them to be set up against third persons, establishes their rank and, where the law so provides, gives them effect. Rights produce their effects between the parties even before publication, unless the law expressly provides otherwise. The CCQ does not explicitly enable advance registration, as does s. 19 of the PPSAs (see below). Because publication is required for third party effectiveness, there seems no way for publication to occur before the hypothec exists. However, the hypothecary agreement may exist at the time of registration, before the hypothec itself exists o (eg, a hypothecary agreement is registered for all present and after-acquired property, and ten days later the grantor acquires property; the hypothec comes into existence on the date of acquisition, but the hypothecary agreement existed before, on the date of registration). o This is effectively advance registration. 2. Failure to Perfect in the PPSA The initial assumption of the PPSA is that the security agreement is effective according to its terms, both between the parties and against third parties (s. 20) Perfection is a pre-condition for effectiveness against certain specific third parties: Buyers without knowledge of the security right (s. 20(1)(c)) Creditors Trustees in bankruptcy (s. 20). Outside these categories, the security right is effective against third parties even without perfection. Which policy is better? The CCQ policy! o Otherwise, there’s going to be a lot of litigation over whether the transferee had knowledge, what the quality of the knowledge was, and (if the transferee is a company) whether the knowledge of a particular person within the company counts as the company having knowledge o Under the CCQ policy, the secured creditor can take as much care as he wants to get the security registered – the law helps those who help themselves! Like God! Neither PPSA has a good faith requirement, which is revolutionary. An unperfected security interest is always subordinate to a perfected security interest, regardless of good faith. Like the CCQ, both registration (ON s. 23, NB s. 25) and delivery (ON s. 22, NB s. 25) are valid modes of perfection. 30 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH “A security interest is perfected when it attaches and when one of the perfecting modes is complete, regardless of the order of occurrence” (s. 19). This provision enables advance registration, in that registration may occur before the security agreement is signed. However, the security interest would remain unperfected until the security agreement was signed, because the latter is required for attachment. As per s. 20, a security right must be perfected to be effective against a buyer without knowledge of the security agreement Note, however, that both PPSAs stipulate that a perfected security right trumps an unperfected security right (ON s. 30, NB s. 35). If there is a dispute between two perfected security interests, the first to register wins – not the first to perfect (ON s. 30, NB s. 35). If there is a dispute between two unperfected security interests, the first to attach wins. If both cover future assets, attachment occurs only when the debtor acquires the property, so the attachment would be simultaneous; here, the time of the security agreement governs. o Compare this with the CCQ, where there cannot be a contest between two unpublished security interests: Neither can have priority against the other, because they are both unpublished, and publication is a prerequisite for third party effectiveness. D. Non-hypothecary Security Rights 1. Publication Requirement for Non-hypothecary Security Devices For all of the non-hypothecary security devices, the security interest must be published to be opposable against third parties. Recall that non-hypothecary security devices are limited to presently owned assets (ie, one cannot sell or retain title in something one does not currently own). Contrast this with a hypothec, which may cover future assets and a universality of assets. The limitation to presently owned assets means that title-based security devices do not drive as large a hole into the concept of hypothec as one might think. Non-hypothecary security devices share the same third party concerns as hypothecs (eg, grantor retains possession in instalment sales and sales with the right of redemption this raises publicity concerns). For this reason, the CCQ imposes an equivalent publication requirement. CCQ 1263 CCQ 1745 CCQ 1750 Onerous Trusts The purpose of an onerous trust established by contract may be to secure the performance of an obligation. If that is the case, to have effect against third persons, the trust must be published in the register of personal and movable real rights or in the land register, according to the movable or immovable nature of the property transferred in trust. Instalment sales: [para. 2] A reservation of ownership in respect of a road vehicle or other movable property determined by regulation, or in respect of any movable property acquired for the service or operation of an enterprise, has effect against third persons only if it has been published; effect against third persons operates from the date of the sale provided the reservation of ownership is published within 15 days. As well, the transfer of such a reservation has effect against third persons only if it has been published. Sale with a right of redemption: [para. 2] A right of redemption in respect of a road vehicle or other movable property 31 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH CCQ 1847 CCQ 1852 2. determined by regulation, or in respect of any movable property acquired for the service or operation of an enterprise, has effect against third persons only if it has been published; effect against third persons operates from the date of the sale provided the right of redemption is published within 15 days. As well, the transfer of such a right of redemption has effect against third persons only if it has been published. Leasing: The rights of ownership of the lessor have effect against third persons only if they have been published; effect against third persons operates from the date of the leasing contract provided the rights are published within 15 days. Lease: Publication is required, however, in the case of rights under a lease with a term of more than one year in respect of a road vehicle or other movable property determined by regulation, or of any movable property required for the service or operation of an enterprise, subject, in the latter case, to regulatory exclusions; effect of such rights against third persons operates from the date of the lease provided they are published within 15 days. A lease with a term of one year or less is deemed to have a term of more than one year if, by the operation of a renewal clause or other covenant to the same effect, the term of the lease may be increased to more than one year. Non-Hypothecary Security Devices and Bankruptcy Recall that neither instalment sales nor leases/leasing creates a new proprietary right: they merely allow the retention of an existing right. This can affect bankruptcy situations, because only the property of the bankrupt is subject to the insolvency regime. Giffen (BC PPSA, 1998) – Iaccobucci Ratio: trustee in bankruptcy has priority over a lessor with an unpublished lease Facts: Unperfected lease of more than a year, with an option to purchase Lessee went bankrupt Lessor seized the vehicle and sold it Two conflicting principles: o Trustee argued that s. 20(b)(i) of the B.C. PPSA stipulates that an security interest is not effective against a trustee in bankruptcy if it is not perfected by the date of the bankruptcy o Lessor argued that the bankrupt never owned the car, and the trustee could not have a better claim to the car than the bankrupt Issue: Who should get the car, the trustee in bankruptcy or the lessor? Holding: The trustee in bankruptcy Reasoning: SCC goes with explicit wording (“plain reading”) of the PPSA: Definition of security interest explicitly includes leases of longer than one year Lessor’s interest in the car is the reservation of title in the car – this falls within the ambit of the PPSA Lessor’s interest in the car was unperfected prior to the bankruptcy Both the BIA and the PPSA recognize that a lessee has a proprietary interest in leased 32 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH goods s. 20(b)(i) of the PPSA modifies the principle that a trustee is limited to the rights in the property enjoyed by the bankrupt o This was a policy choice of the legislature Issue is not ownership of the vehicle, but priority to it o And provinces have the right to change the rules about priority Lefebvre (CCQ, 2004) – LeBel Ratio: lessor with an unpublished lease has priority over a trustee in bankruptcy Facts: Two individuals leased cars for 36-month terms The lessors did not publish the leases within the 15 days required by art. 1852 CCQ The lessees went bankrupt Issue: Who should get the cars, the trustees in bankruptcy or the lessors? Holding: The lessors Reasoning: Does a lease confer a right of ownership? Can it be treated as a hypothec? NO A lease contract does not effect a conveyance of ownership between lessee and lessor o Lessee only has status of holder – thus property must be surrendered upon termination of lease Conceptual background: o During the reform of the CCQ, the reformers made a conscious choice NOT to organize the law of real security around the concept of presumption of hypothec o Instead, maintained the fundamental distinction between the concepts of security and ownership o No CCQ provisions transform the lesssor’s right of ownership into a hypothec o To treat the lease as a hypothec would go against this conscious decision to avoid a presumption of hypothec Function of publication is not to create rights between parties (2941 para. 2), but rather to protect third parties (2941 para. 1) o In this case, publication doesn’t create the lessor’s right of ownership – that exists anyway Legislature can take a more active role: o CCQ 1756: buyer in a sale of a right of redemption is deemed to be a hypothecary creditor o BIA ss. 25 and 28: seller in a conditional or instalment sale or buyer in a sale with a right of redemption is deemed to be a secured creditor Neither the CCQ nor the BIA did so in this case with respect to lease, however Can a trustee be characterized as a third person? NO Trustee’s position is very complex and not easily defined Trustee cannot be regarded as a “third person” in relation to the bankrupt, for the purpose of art. 1852 o Trustee’s seisin is limited to the property in the debtor’s patrimony o Apart from special powers, trustee has no more rights with respect to the property than the debtor 33 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH Distinguishable from Giffen: In Giffen, the B.C. legislation itself defined the respective rights of lessor and trustee in a lease/bankrupt situation The trustee was deliberately given an interest greater than that of the bankrupt Confusing decision: why does a trustee in bankruptcy count as a third person for the purposes of 2663 (validity of an unregistered hypothec) but not for the purposes of 1852 (validity of an unregistered lease)? Same question applies to Oullet with respect to 1745 (validity of an unregistered instalment sale) IN A FACT PATTERN, PRESENT BOTH SIDES The Bankruptcy and Insolvency Act was amended to include instalment sellers within the definition of secured creditors. By transforming the instalment buyer into the owner, the object of the sale was now part of the property of the bankrupt. This would mean that trustees are third persons (if the bankrupt was the instalment buyer). They did not include “lessors” within the definition, so Lefebvre remains good law (though not Ouellet) Ouellet (CCQ, 2004) – LeBel Facts: Instalment sale – instalment buyer went bankrupt before the sale was complete Instalment sale had not been published within the 15-day time limit set by art. 1745 1749: instalment seller whose right was unpublished can only reclaim the property if it is in the hands of the original buyer Issue: Who should get the property, the trustee in bankruptcy or the instalment sellers? Holding: The instalments sellers (but the result would be different today, post-BIA amendment) Reasoning: The reservation of ownership must not be equated with a security within the meaning of the Civil Code of Québec The legal relationship between the original buyer and the seller must be interpreted as one of ownership Since a failure to publish does not have the effect of conveying ownership to the original buyer, the property sold does not become part of his or her patrimony Trustee is only vested with the rights that the debtor had in her property Trustee can’t be considered a third party However, the definition of “secured creditor” in the BIA now equates a reservation of ownership in an instalment sale with a security for the trustee’s purposes o Thus, an owner’s reservation of ownership in an instalment sale is now of no effect against a trustee unless it is published BIA s. 2 [Definition of “secured creditor”] “Secured creditor” means a person holding a mortgage, hypothec, pledge, charge or lien on or against the property of the debtor or any part of that property as security for a debt due or accruing due to the person from the debtor, or a person whose claim is based on, or secured by, a negotiable instrument held as collateral security and on which the debtor is only indirectly or secondarily liable, and includes (a) a person who has a right of retention or a prior claim constituting a real right, within the meaning of the Civil Code of Québec or any other statute of 34 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH the Province of Quebec, on or against the property of the debtor or any part of that property, or (b) any of: i. the vendor of any property sold to the debtor under a conditional or instalment sale, ii. the purchaser of any property from the debtor subject to a right of redemption, or iii. the trustee of a trust constituted by the debtor to secure the performance of an obligation, if the exercise of the person’s rights is subject to the provisions of Book Six of the Civil Code of Québec entitled Prior Claims and Hypothecs that deal with the exercise of hypothecary rights; Note that lessors are still not included in the BIA definition of “secured creditor”, so Lefebvre is still good law E. Effect of Change of Mode of Publication/Perfection 1. Change of Mode of Publication in the CCQ As per CCQ 2707, a movable hypothec with delivery can be registered later, as long as publication is uninterrupted. CCQ 2707 A movable hypothec granted with delivery may be published by registration at a later date, provided publication is not interrupted. However, the converse is not true: a hypothec cannot be registered first, and then published by delivery. 2. Change of Mode of Perfection in the PPSA The PPSA allows changes in the mode of perfection (registration or delivery), as long as there is no lapse (ON s. 21; NB s. 23). If there has been no lapse, then the secured creditor is continuously perfected. If there is a lapse, then the secured creditor loses priority as soon as the lapse occurs. He may reperfect, but perfection will start from that date. If there was an SC2 previously, he now becomes SC1. The PPSA allows secured creditors to switch modes because continuity is desirable for third party information and priority purposes. As long as these goals are accomplished, the mode itself is unimportant. F. Perfection by Delivery Sometimes a security right is treated as automatically published/perfected (ie, creation is sufficient for publication/perfection). 1. Perfection by Delivery in the CCQ 35 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH The CCQ stipulates in CCQ 2703 that movable hypothecs with delivery are published for as long as the creditor continuously holds the property. CCQ 2703 A movable hypothec with delivery is published by the creditor's holding the property or title, and remains so only as long as he continues to hold it. This strictness of the rule is qualified in CCQ 2704, which deems that the creditor continuously holds the property even if his holding is prevented by the act of a third person, or the temporary handing over to the grantor, or the temporary handing over to another to repair or improvement. CCQ 2704 Holding is continuous even if its exercise is prevented by the act of a third person without the consent of the creditor or is temporarily interrupted by the handing over of the property or title to the grantor or to a third person for evaluation, repair, transformation or improvement. “The act of a third person without the consent of the creditor” may refer to someone else who has a hypothecary right, and who decides to enforce. In this situation, the original creditor is deemed to continuously hold. However, if the third person is indeed another hypothecary creditor, the original creditor cannot revendicate, as per CCQ 2706. CCQ 2706 A creditor prevented from holding the property may revendicate it from the person holding it, unless he is prevented as a result of the exercise of hypothecary rights or a seizure in execution by another creditor. Bills of lading and negotiable instruments are dealt with at CCQ 2708. CCQ A movable hypothec on property represented by a bill of lading or other negotiable 2708 instrument or on claims may be set up against the creditors of the grantor from the time the creditor gives value, provided the title is remitted to him within ten days of that time. First, creditor gives value Then, (up to ten days later), grantor gives title Different approach from PPSA, where bank is protected for 10-15 days AFTER the bill of lading is returned to the buyer As per CCQ 2710, movable hypothecs on claims may be granted with or without delivery, whether they are specific or on a universality of claims. CCQ 2710 A movable hypothec on a claim held by the grantor against a third person or on a universality of claims may be granted with or without delivery… If the movable hypothec is on a universality of claims, CCQ 2711 stipulates that it must be published in the appropriate registry, whether it’s published by delivery or not. CCQ 2711 A hypothec on a universality of claims, even when granted by the remittance of the title to the creditor, shall be entered in the proper register. CCQ 2710 seems to contemplate that a movable hypothec on a universality of claims may be published by delivery, but CCQ 2711 appears to contradict this. If a secured creditor attempts to publish by delivery via notification, what are the priority implications given CCQ 2711? Is registration the preferred mode of publication for priority purposes? Blouin has not answered any of these questions. 36 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH Blouin SCC decided it was possible to have a moveable hypothec with delivery on a simple claim In such a case, giving the debtor notification would constitute delivery The act of delivery is taking control, and control occurs when the debtor is notified, because this is when he has to pay If there is effective control, the “holding” requirement in CCQ 2703 is met. The implication of the ruling is that interpreting the CCQ to allow the hypothecation of simple claims with delivery, it expands the range of assets that natural persons may use to access credit. Not well-received in the profession Would have preferred SCC to interpret arts. 2710 to be mistakenly drafted, and interpret it as the PPSA Should have been impossible to do this by “delivery”: should have required registration The current way this is done raises transaction costs o Can’t rely on the fact that the registry will be an exhaustive list of the security interests on an asset, since there is an alternative form of publication: delivery! Problem solved (sort of) by inserting the word “physical” in 2702 Suggests that notification can no longer constitute delivery? However, the wording of 2710 and 2711 still contemplate non-physical delivery: inherent contradiction Walsh: however, it does seem like non-physical delivery is now impossible – thus, registration would seem to be the only way o But we can’t be sure of that until we get some jurisprudence on this 2. Automatic Perfection in the PPSA As per ON s. 24.2 and NB s. 26.1, certain kinds of security interest may be perfected by possession, and remains perfected for the first ten days (ON) or fifteen days (NB) after the collateral comes under the control of the debtor. This is most commonly applied to instruments (eg, cheques, promissory notes), certificated securities, and documents of title (eg, bills of lading or warehouse receipts). A negotiable document of title operates as the equivalent of goods for the purpose of transferring title to the buyer. It can thus serve as collateral; the buyer will obtain financing from the bank to purchase goods, and the bank will take a security interest in the bill of lading as collateral. This is usually a short-term financing, because the buyer will sell the goods in turn, which means the bank must relinquish the bill of lading. o It is impractical for the bank to register their security interest, because they will likely relinquish the bill of lading within a few days. o Therefore, the interest remains perfected for the first 10 or 15 days after the bill of lading is returned to the buyer. After this time, the bank has to register to maintain continuous priority. 37 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH IV. REGISTRATION A. Type of Registry System Both the PPSA and the CCQ are notice-based registry systems The notice of security right is what is registered, not the juridical act that creates the security right (ie, the security agreement). The notice contains the names and addresses of the secured creditor and the grantor, a description of the collateral, and the duration requested. Movables registries are indexed by the name of the grantor, not by the movable asset (CCQ 2980). This allows a universality of goods to be registered, as there is no need for a separate descriptor for each good. Creditors can thus achieve third party effectiveness through a single filing capturing “all inventory” or “all present and after-acquired personal property.” The exception to this rule is road vehicles and similar serial numbered vehicles. For these, the serial number of the movable itself must be included in the notice, such that one may search by serial number (vehicle ID number [VIN]) as well as by grantor name. o The ability to search by VIN is important because of these movables’ significant resale market. In Québec, there is a separate database for VINs (road vehicles), but not for other numbers. These simply go into the register, but are not actually searchable. The main import of the law is thus to expand the categories of things on which natural persons may take a hypothec. In ON, road vehicles are the only movables that can be searched by serial number (vehicle ID number, or VIN). In the other PPSA jurisdictions, such movables include road vehicles, aircraft, aircraft engines, and boats. These do not have a fixed universal number Aircraft are searched by the Ministry of Transport registry number Boats are searched by the federal licence number (licensure is not required for all boats, but an indirect effect of the registry was that people began licensing boats in order to obtain financing) this is interesting, since the PPSA certainly does not encourage or discourage federal licensure). Contrast movables registries with land registries, which are document registries The title document itself is registered. This is because land registries are registries of ownership; a prospective buyer must be able to determine whether the seller is in fact the owner of the parcel he is selling. Accordingly, land registries are indexed by the specifically described parcel of land (CCQ 2972). One cannot register a hypothec against a universality of land, only on specific parcels. The land register and register of personal and movable real rights are established by CCQ 2969. CCQ 2969 A land register and a register of mentions are kept in the Land Registry Office, together with any other register the keeping of which is prescribed by law or by the regulations under this Book. In addition, a register of personal and movable real rights in kept in the Personal and Movable Real Rights Registry Office. The Land Registrar and the Personal and Movable Real Rights Registrar are charged, respectively, with keeping such registers. 38 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH B. Advanced Registration 1. Advanced Registration in the PPSA The PPSA explicitly permits advanced registration (recall s. 19). Registration may precede the security agreement because the registry is notice-based (ie, the security agreement itself does not have to be registered). The PPSA also permits multiple agreement registration, in that one filing can capture security rights arising from more than one agreement (ON 45(4), NB 43(6)). As long as the parties and collateral description are unchanged, there is no need for additional filings. The expiry date of the security agreement is not necessarily the same as that of the registration. The PPSA allows registration to expire after 25 years. It is also possible to purchase infinity. In ON, there is no advanced registration or multiple agreement registration for security over consumer goods, and the maximum expiry date is five years. 2. Advanced Registration in the CCQ The CCQ does not permit advanced registration. The notice must identify the juridical act (ie, security agreement); As a result, the CCQ does not permit multiple agreement registration either, since a single registration can only refer to a single security agreement. There is a one-to-one relationship between the registration of the hypothec and the security agreement. Recall that the notice must also stipulate the value of the hypothec (ie, the maximum amount the hypothec will cover). Advanced registration is possible in a sense, in that the security agreement might cover future assets. But the security right will only come into existence once the grantor acquires those assets. 3. Policy Justifications for/against Advanced Registration PPSA Approach Designed to protect the secured creditor’s priority against other secured creditors (but see ON PPSA exception for consumer goods, below) o Recall that priority between security rights dates from the time of registration, even when the security agreement comes into existence later. o But advanced registration does not necessarily protect against other kinds of claimants. o To be effective against a buyer, for example, the security right must be perfected (registration and attachment) – unless the buyer had knowledge of the security right (s. 20). Thus, advanced registration would be invalid against a buyer without knowledge. Knowledge must be knowledge of the security right, not merely of the registration. If the buyer had knowledge, then advanced registration (ie, an unperfected security right) is effective against him. 39 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH Saves money for everybody who has to file registrations False registrations aren’t a serious worry (see below) CCQ Approach CCQ is concerned about the possibility of false registrations – could impair the debtor’s right to get other financing o Thus, it is willing to impose formalities (eg, secured creditor’s consent must be notarized) Because of the CCQ’s presumption that the registration is evidence (2944); it is far more concerned that the registration be legitimate. o PPSA would counter that a secured creditor is unlikely to go to the trouble of registering unless it is serious about following through – don’t think the risk is serious enough to warrant lots of formalities in the registration process o However, PPSAs have put in provisions that reflect some concern about this issue: A procedure for the compulsory discharge of the record to the extent that it fails to reflect the real agreement between the parties: ON s. 57, NB s. 50). This is why ON does not permit advanced registration for consumer goods, for example Other provinces do permit this, however, arguing that registration is not evidence of the existence of a security right; it merely signals that a right may exist. Conceptually troubling to register a transaction that hasn’t happened yet o The CCQ assumes there is a hypothecary agreement in existence at the time the hypothec comes into being. Desire for the registration to serve an evidentiary function o As per CCQ 2944, registration creates a simple presumption of the existence of the security right. o This presumption, plus the disallowance of advanced registration, indicates that registration under the CCQ provides evidence of the existence of the security right. o This is true even though the juridical act creating the security right is not registered. CCQ 2944 o Registration of a right in the register of personal and movable real rights or the land register carries, in respect of all persons, simple presumption of the existence of that right. Who does this benefit? What other classes of individuals, aside from SCs, are effected by certain awareness of all security rights? All third parties with an interest, present or future buyers, unsecured creditors, other secured creditors, Gs. Relative merits: While the PPSA protects SCs, one may argue that the CCQ only marginally protects other parties, particularly grantors. Registration limits the grantor’s ability to obtain credit and impairs his ability to access further credit (because any additional creditor would be at least second in line). In contrast, the PPSA doesn’t disadvantage the grantor because registration doesn’t necessarily indicate the existence of a security right. o On the other hand, Prof says this isn’t a good reason; lenders will still say that the presence of a registered security interest may mean a security right will come into existence very soon, already with priority, so the CCQ approach can’t possible disadvantage grantors in this regard any more than the PPSA approach does. On the contrary, the CCQ encourages the easy flow of credit by preventing people from registering false claims. On the other hand, the requirement that the SC’s consent to the security agreement must be notarized adds cost and administrative complexity Defence of PPSA: while some may argue that advance registration permits potential creditors to abuse grantors/debtors by registering non-existent security interests, the mere option of 40 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH advanced registration does not necessarily lead to abuse by SCs – it’s only problematic if you don’t ultimately get a security agreement. It’s only bad to the grantor if it’s false (i.e. if no security agreement is anticipated) o There have been a few cases involving unauthorized registration. o To deal with this possibility, the PPSA created a simple administrative procedure for allowing a grantor to compel a discharge of a registration (i.e. a cancellation) to the extent that it doesn’t reflect an agreement btwn the parties. o It’s different in Ont you have to get a court order. These mechanisms are set out in 50 (NB) and 57 (Ont). Which approach you prefer depends on how many bogeymen you see in the market – whether you think that the risk of false registrations justifies making advanced registration impossible o PPSA: this is not a sufficiently serious problem to warrant setting up further formalities wrt registration (e.g. it hasn’t resulted in the deterioration of the registry; the market has more or less behaved). o CCQ: this is a troubling possibility, especially given the presumption of hypothecary proof (the two go hand in hand). The PPSA sacrifices a measure of security/legitimacy in order to facilitate filings, while the CCQ increases the cost of credit for everyone by creating administrative hurdles (because of its fear of the false filing bogeyman). C. Required Registration Information Certain information must appear on the filing, including the identity of the debtor and secured creditor; collateral description; duration of registration; and in Québec, the maximum value of the hypothec. The collateral description is narrative, and is accompanied by the serial number if necessary (in a separate searchable field). As per the CCQ, the duration of the registration requires reference to the juridical act. 1. Maximum Value The maximum value is the most significant difference between the CCQ and PPSA. The CCQ requires the maximum value of the hypothec to appear on the filing, while the PPSA does not. CCQ: subsequent secured creditors can loan, knowing that there is sufficient residual value in the asset. PPSA: there is greater risk in loaning as SC2, because if SC1 makes additional advances, the residual value will diminish accordingly. The only protection for SC2 in such a situation would be if SC1 undertook to cede priority in the amount of SC2’s loan. Why would SC1 choose to subordinate itself? o If it has loaned to a business, it may wish the business to continue without extending additional financing itself, while additional financing by another will ensure that its debt obligation is met. a. Policy Justifications for Maximum Value CCQ Approach: By imposing the maximum value requirement, the CCQ wishes to promote credit market competition. o Gives greater freedom to grantor: SC1 does not have to be the sole source of credit, as cheaper financing may be available elsewhere. 41 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH Enabling SC2 to capture the residual value will make SC1 less reluctant to finance riskier enterprises. o The underlying assumption is that once SC1 captures the grantor’s business, he will rentseek, and take advantage of his monopoly. o The maximum value requirement is intended to prevent this. Allows grantor to benefit on the off-chance that the asset increases in value PPSA Approach Assumes that the first-in-time financier is the optimal source of credit from the grantor’s perspective. The law should encourage financing from this source, because he’ll be more likely to lend at the outset if he knows he will capture future business o This is especially pertinent for small and medium-sized businesses, which banks have a disincentive to lend to – need every incentive we can get to get financing for these operations (especially since these are the operations who will benefit least from the CCQ protections – see below) CCQ argument assumes that SC1 under the CCQ rules will not insist on an exaggerated sum that will always ensure him first priority, leaving no residual value for subsequent creditors. o It also assumes the grantor has enough bargaining power to ensure this will not occur. o This level of bargaining power implies a medium-to-large sized business with choices, not a small-to-medium sized enterprise (SME) The whole point of both the CCQ and the PPSA is to encourage financing, particularly for SMEs. Banks have a disincentive to lend to SMEs, both because of their inherent risk and because of their information opacity/asymmetry. Given the CCQ assumptions, who is the grantor we are trying to assist in the market? D. Effect of Error or Omissions Errors and omissions usually arise in connection with the grantor’s legal name, particularly where the grantor is a natural person. The court’s test is whether the error/omission would mislead a reasonable searcher in a material way. The underlying question is what the system accepts as a legal name. Now, most banks and lending institutions will verify the grantor’s name against a legal document. The rule is, when in doubt, search under both names. Lambert (ON PPSA, 1994) Facts: A lessor registered a leasing agreement: o Correct last name o Correct VIN o Correct date of birth o Incorrect first name Lessee went bankrupt Lessor informed the trustee of its rights Trustee did registry searches by name, but not by VIN, even though they had the VIN o A VIN search would have revealed the security interest Issue: Does the error in registration render the registration invalid? Holding: No 42 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH Reasoning: The registration was not done according to the strict guidelines of s. 16 However, s. 46(4) specifies that an error will only invalidate a registration if “a reasonable person is likely to be misled materially by the error or omission” Objective Test Rejects subjective approach (idea that what matters is whether the person who searched actually was misled) Legislature clearly applied an objective, reasonable person standard o Important distinction from s. 9(2) of the PPSA (which actually refers to a party being misled) Thus, don’t require any evidence that the person who searched was actually misled in s. 46(4) cases Don’t want test to be too strict (too heavy a burden on secured creditors) or too lenient (too heavy a burden on prospective creditors and purchasers) Characteristics of the “reasonable person” o A person using the registry as it was intended: that is, a potential buyer or secured creditor o A “reasonably competent” person familiar with the search facilities of the registry o A person who knows that you can search for vehicles by name and by VIN o A person would do both a name search and a VIN search, where the collateral is a motor vehicle Especially since this would be the best way to discover a security interest in case other parties had owned the car in the past A reasonable person would not be misled if the name was wrong but the VIN was correct But a reasonable person WOULD be misled if the name was correct but the VIN was wrong Note that in the Atlantic provinces, both pieces of information must be correct for a valid registration. Other provinces are somewhere in the middle. Which policy is better: Ontario (Lambert) or the other provinces’? Both name and serial number should be correct! Not all of the parties who might be interested in checking will have access to the information as to serial number that you would need in order to check which assets belonging to a party are encumbered: o Trustee o Judgment creditor There are many reasons why even another secured creditor might not check: o Grantor has many serial numbered assets and multiple searches are prohibitively expensive o Searcher knows the grantor and is not worried about anterior possessors). Incentivizes the secured creditor to things right – saves money for the whole system – and punishes him (as the actual wrongdoer) when he fucks up If the legislature has held both pieces of information to be necessary, how can the court say otherwise? Just the serial number! Too heavy a burden on the secured creditor Potentially allows substantive injustice on the basis of a technicality Most important thing is that the law is certain, and if everybody knows they have to check serial numbers, there should be no reason why they don’t 43 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH Exode Automobile Inc. (CCQ, 2005) Facts: The creditor advanced money to Exode, and the notary registered the hypothec with two errors: o The maximum value of the hypothec was greater than the maximum value in the juridical act o The registration made reference to the wrong juridical act The court held that the registration was valid despite the errors. Reasoning: Test: does the registration error render ineffective the publication of rights? Can’t give a purely theoretical response – must take account of the circumstances particular to each case to see if they can create a confusion, a source of error, or prejudice to a third party “Seules devraient être sanctionnées d’inopposabilité les erreurs qui empêchent d’atteindre la finalité poursuivie par le régime de publicité des droits et qui, en conséquence, rendent cette publicité inefficace.” The registration of a higher maximum value than the actual amount would not prejudice third parties o Indeed, it is often the case that the secured creditor will register a higher sum than they lend The incorrect reference is irrelevant because the document is in the hands of the notary, who is not obliged to show it o Thus, listing the wrong document didn’t deprive any third party of the right to see it A counterargument is that even if registration of a higher amount does not prejudice third parties, it does prejudice the interests of the grantor. V. COMPETING CLAIMANTS: PRIORITY AMONGST SECURED CREDITORS A. General Rule The general rule is that priority goes to the first to publish/register. 1. First to Publish Rule in the CCQ Under the CCQ, priority is determined by the order of publication. Recall that publication is a prerequisite for third party effectiveness, as per CCQ 2941. CCQ 2941 also stipulates that publication establishes rank. CCQ 2941 Publication of rights allows them to be set up against third persons, establishes their rank and, where the law so provides, gives them effect. Rights produce their effects between the parties even before publication, unless the law expressly provides otherwise. Priority is accorded to whoever publishes first, either by the date of delivery or the date of registration in the correct registry (CCQ 2945). 2. First to Register Rule in the PPSA 44 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH Because the PPSA permits advanced registration, the priority rule is slightly more convoluted: priority goes to the first to register, not the first to perfect (because registration can occur in advance of perfection). B. Knowledge/Notice of an Unpublished/Unperfected Right 1. Knowledge in the CCQ Knowledge of an unpublished security right is irrelevant, as per CCQ 2963. A creditor cannot assert priority on the basis of his knowledge of the security right. He must register. CCQ 2963 2. Notice given or knowledge acquired of a right that has not been published never compensates for absence of publication. Knowledge in the PPSA The PPSA never says that knowledge does not compensate for the failure to perfect – since the PPSA indicates in other places where knowledge has an impact (e.g. 20(3)), we can assume it doesn’t play a role here Knowledge has nothing to do with good faith (i.e., the assumption that anyone who would take a security right knowing about a previous right must be in good faith, because they would not take the subordinate right unless willing to cede priority). This assumption no longer holds. The whole purpose of the registry system is that people should rely on it, so prior knowledge becomes irrelevant. C. Priority with Respect to Later Advances 1. Priority and Later Advances in the CCQ The CCQ permits hypothecs covering a universality of assets, which includes future and after-acquired assets. For a hypothec on a universality of immovables, CCQ 2949 stipulates that registration must be effected against subsequently acquired immovables on an item-by-item basis. The creditor must register against each parcel of land to achieve third party effectiveness. For a hypothec on a universality of movables, CCQ 2950 stipulates a single registration under the grantor’s name, covering present and future assets. There is no need for subsequent registrations. As per CCQ 2955, the rank of a floating hypothec is determined by the point of crystallization. A floating hypothec covers a universality, but does not attach until the secured creditor asserts his right (ie, point of crystallization). Floating hypothecs are not used; they contemplate inventory, but as inventory is easily covered by a general hypothec that stipulates present and after-acquired property, the latter is more often used. Recall that hypothecs must include a maximum value, as per CCQ 2689. This means that creditors may assert priority over later advances, but only up to the maximum value. 45 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH 2. Priority and Later Advances in the PPSA The PPSA imposes no limitation on future advances (ON s. 30(3), NB s. 35(5)). Recall that there is no maximum value stipulation, and multiple security agreements are covered by a single filing. Because of this, the first secured creditor may have infinite priority. 3. Policy Justifications with Respect to Later Advances Both regimes allow the grantor to grant security over future assets to one secured creditor, who might in theory assert infinite priority. This raises the possibility of a monopoly. The CCQ would argue that this encourages the secured creditor to behave in monopolistic and rent seeking fashion, and the grantor will end up paying more for his credit than he ought. The PPSA would argue that this system encourages secured creditors to lend to SMEs, which increases SMEs’ access to credit. Moreover, if there is a default, it is more efficient to have one primary creditor with priority over most assets. These perspectives are based on different assumptions regarding market behaviour. Because the CCQ is worried about monopolies and rent seeking behaviour, it imposes the maximum value requirement. o This favours competition for the grantor’s financing needs, and enables the grantor to seek competitive financing as its assets grow. The PPSA assumes that the first lender is more likely to continue lending if he can capture future business, which increases the likelihood that small and medium sized grantors will be financed. D. Exceptions to General First to Publish/Register Rule 1. Purchase Money Super Priority Purchase money financing is acquisition-secured financing (ie, the creditor takes security in the very thing his loan enables the grantor to purchase). Purchase money financing is an exception to the first to register rule, and is said to have “super priority.” If SC1 has a security interest in all future assets, and SC2 has a purchase money security interest on a specific asset, SC2 has priority over SC1. Risks The risk here is that the grantor leverages himself to several different lenders, thereby undercutting SC1’s security interest. There is also the risk of double-financing: if SC1 extends advances against inventory, the grantor might actually have used SC2’s loan to purchase the inventory. Justifications The justification for purchase money super priority is that it is specialized. o There is no reason for SC1 to complain, because nothing has been taken from him; the asset would not have entered the grantor’s patrimony without the loan by SC2. The risk of double-financing can be avoided through effective monitoring by SC1 as it makes its advances. The larger question is whether SC1 is the best lender, or whether competition amongst subsequent creditors should be encouraged. 46 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH a. Of course, the first secured creditor can always threaten to halt financing – or, worse, call it a default and enforce the security – to prevent this, especially for inventory thus, this “bargaining power” is a bit illusory Purchase Money Security Interest in the PPSA The PPSAs distinguish between purchase money security interests in inventory, and those other than in inventory (ON s. 33, NB s. 34). In both cases, SC2 can assert priority over SC1 to the extent that the money is used to acquire the asset. For non-inventory purchase money financing, super priority may be asserted only if the security right is registered within 10 (ON) or 15 (NB) days after the grantor acquires possession. For inventory purchase money financing, there is no grace period. Registration must occur before the grantor takes possession, and SC2 must send a written notice to SC1 of its intention to acquire a purchase money security interest. If either requirement is unsatisfied, the general first to register rule applies. The PPSA wants purchase money super priority to extend to anyone who extends purchase money financing (i.e., not just to vendors, as in the CCQ). b. Purchase Money Security Interest in the CCQ i. Vendor’s Hypothec The CCQ equivalent of the purchase money security interest is the vendor’s hypothec, which enjoys super priority as per CCQ 2948 with respect to immovables, and as per CCQ 2954 with respect to movables. Here, the vendor is selling the asset in which security is being taken. CCQ 2948 An immovable hypothec ranks only from registration of the grantor’s title, but after the vendor’s hypothec created in the grantor’s act of acquisition. If several hypothecs have been registered before the grantor’s title, they rank in the order of their respective registrations. A movable hypothec acquired on the movable of another or on a future movable ranks from the time of its registration but after the vendor’s hypothec, if any, created in the grantor’s act of acquisition, provided it is published within fifteen days after the sale. The effect of art. 2954 was to eliminate any practical distinction between vendor hypothecs and installment sales – make the law more coherent by not making huge differences in effect rest on technical differences CCQ 2954 The other hypothecs are ranked from the time of their registration, but always subject to the vendor’s hypothec. The vendor’s hypothec must be published within fifteen days. The vendor’s hypothec is an alternative to the instalment sale. An instalment seller always has priority because he retains title. Here, title will not be retained; it will pass upon delivery of the object, but the vendor gets a hypothec that trumps all others. 47 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH Maschinenfabrik Rieter (QCCA, 2005) Facts: 1995 and 1997: La Financiere du Quebec granted loans to Canadian Fidelity Mills, secured by hypothecs without delivery on the universality of the present and future movable property of the debtor – hypothecs were published 2000: Maschinenfabrik Rieter sold movable property to debtor by way of an instalment sales contract – published reservation of ownership AFTER the 15 days allowed by art. 1745 2001: Debtor made a notice that it was going to file for bankruptcy Issue: Who should get the equipment, FQ (the first secured creditor) or MR (the instalment seller) Majority: MR cannot repossess: due to the lapse of the time period FQ ranks ahead of MR. Thus, even though MR was the actual owner of the property, they rank behind FQ as an SC Dissent (Nuss): Based on Ouellet and Lefebvre, MR as an installment seller didn’t have simply a security interest – they had a right of ownership Thus the ‘grantor’ never had title to the machinery, which means that the first secured creditor could never have had a security interest on the machinery (it never attached) Protection of the first secured creditor is not necessary – secured creditor never relied on this asset, so there is no loss The change to the definition of “secured creditor” in the B.I.A. (which would have altered the disposition in Ouellet, has no effect here, since the dispute is not between an instalment seller and a trustee, but rather between an instalment seller and a secured creditor ii. The PPSA doesn’t worry about this because it treats instalment sales as security interests o This result is certainty, but it can represent huge losses which vendors may have much more difficulty absorbing than other SCs such as banks. o Walsh: The true owner loses because the law believes there is a greater good Non-hypothecary Devices Instead of relying on a vendor’s hypothec, the vendor has the option of achieving super priority through a title retention arrangement designed to prevent the assets from entering the debtor’s patrimony. This can be done through: o An instalment sale o A sale with the right of redemption o Or lease/leasing. The vendor must register within 15 days, just as with a vendor’s hypothec. The fifteen day requirement is modified in CCQ 2961.1, which allows a single registration for the debtor’s ongoing acquisition of inventory. That is, the vendor may register his reservation of title, or right to redeem title, or title under a lease through a single registration, as opposed to doing so every fifteen days a new piece of inventory is acquired. The registration is valid for ten years, after which time it must be renewed. 48 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH iii. General The CCQ does not impose a notice requirement as does the PPSA; SC2 does not have to inform SC1 of his intention to extend purchase money security. He simply has to register within fifteen days (or effect a single registration under CCQ 2961.1). This applies to both inventory and non-inventory financing. c. Policy Differences in Purchase Money Super Priority Note that the CCQ approach imposes the burden of verification upon SC1, while the PPSA imposes it upon SC2 (look at different notice requirements) The CCQ clearly wants vendors to benefit from purchase money super priority. Placing the burden of verification upon SC1 will enable the grantor to access other kinds of financing, while not prejudicing SC1’s interests, as the burden is not excessive. Also, SC1 is probably a bank, and will have considerably more resources than SC2, who is a vendor. The thrust is to allow the grantor to access different sources of financing. The PPSA wants people beyond just vendors to benefit from purchase money super priority. Constant monitoring is too onerous for SC1, so notification should lie with SC2. The assumption is that SC1 is always the best financier. Which approach is better? Quebec! o Because the super-priority is restricted to vendors, this makes it easier for the first creditor – can demand a list of vendors and conditions of sale from the vendors Much easier to monitor (since the only people who could usurp your position are the other vendors of your customer) Under the PPSA, there are lots of other people who could usurp your position, including other banks o PPSA system is a hassle – requires first creditors to put clauses in their contracts defeating second creditors, requires a bunch of advanced registration, requires parties to be vigilant for PMSI advanced notices PPSA! Ultimately, what the rule is may be less important than the requirement that the rule be clear, since creditors can always derogate from the rule through inter-creditor agreements 2. Serial Numbered Goods Serial numbered goods are another exception to the first to publish/register rule. a. Serial Numbered Goods in the PPSA Under the PPSAs, serial numbered goods can be held as equipment, consumer goods, or inventory. i. Equipment Under the NB PPSA, the serial numbered good may be captured by the narrative description, if it is used as equipment. However, failure to include the serial number can result in the loss of priority to a buyer/lessee, or to another secured creditor. 49 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH For example, if SC1 registers without the serial number, and the grantor sells the good to a buyer, the buyer takes free. If the grantor grants a security interest to SC2, and SC2 registers with the serial number, SC2 will trump SC1 (ss. 30(6), 35(4)). Under the ON PPSA (s. 28(5)), the buyer takes free, but SC2 remains subordinated. SC1 retains his priority. ii. Consumer Goods If the serial numbered good is a consumer good, inclusion of the serial number is mandatory. Failure to include the serial number means the security right is not assertable against anyone. This is the Regulations to both the ON and NB PPSAs. iii. Inventory If the serial numbered good is inventory, there is no requirement to include the serial number, and no priority repercussions. A narrative description of the inventory will suffice. b. Serial Numbered Goods in the CCQ The CCQ requires a description file with respect to road vehicles. The Regulations make no distinction as to inventory, equipment, and consumer goods; there is merely a general requirement to include the VIN, and nothing about priority consequences. The priority implications of failing to include the VIN are therefore ambiguous. If the road vehicle was part of a universality, then the VIN would probably not be required; if the security interest was in that specific vehicle, then it probably would be required. 3. Voluntary Subordination of Priority Between Secured Creditors a. Voluntary Subordination in the CCQ If one secured creditor chooses to cede priority to another, CCQ 2956 says this cession must be published. Cession of rank between hypothecary creditors shall be published. CCQ 2956 Where it occurs, the rank of the creditors is inverted, to the extent of their respective claims, but in such a manner as not to prejudice any intermediate creditors. Why should cession be published? Because of the CCQ enforcement provisions. If there is a judicial sale, the court must know if anyone has ceded priority so as to fairly allocate the proceeds. The CCQ also stipulates that cession may not prejudice the rights of an intermediate creditor (ie, if SC1 and SC3 agree, SC3 cannot use their agreement to leapfrog ahead of SC2). b. Voluntary Subordination in the PPSA The PPSA does not require publication of cession; it is effective according to its terms (ON s. 38, NB s. 40). It has the same effect as the CCQ in disallowing SC3 to prejudice an intermediate creditor. Voluntary subordination may create a circular priority scenario under the PPSA, such that SC1 is subordinated to SC3. The law tries to avoid this, because a fair allocation of assets becomes so difficult. 50 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH For example, if registration lapses, a creditor may preserve his priority rank by re-registering within 30 days of the lapse under the NB PPSA (s. 35(7)). However, he is subordinated to any subsequent creditor who registers between the time of the lapse and the time of his re-registration. If SC3 registers before SC1’s re-registration, a circular priority contest results. The ON PPSA does not impose a 30 day limit. A secured creditor may re-register at any time, and will regain the priority he had initially. But he will be subordinated to any intervening creditor, just as in the above scenario. Because of the greater window within which an intervening creditor may appear, there is a correspondingly greater risk of circular priority contests. The PPSAs essentially allow unlimited registrations, since registrations may be renewed and one registration may cover multiple agreements. c. Intercreditor Agreements An intercreditor agreement is an agreement to cede priority between two secured creditors. The grantor and secured creditor might also agree that the grantor will not grant security rights to anyone except a certain class of creditor (eg, an agreement to only grant purchase money security interests). Intercreditor agreements do not have to be legally enforceable Ks, but must display a clear intent to benefit the other creditor. If there is an intercreditor agreement between SC1 and SC3, the agreement cannot prejudice the interests of SC2. For example, if SC1 and SC2 are owed $100K and SC3 is owed $50K: the first $100K goes to SC1, and the second $100K goes to SC2. Because of SC1’s subordination to SC3, SC1 pays $50K to SC3. Only SC1 is losing here, not SC2. And SC1 has agreed to be subordinated, so his loss is acceptable. The above scenario becomes dangerous where there is a step-aside clause, such that SC1 asserts no priority until SC3 is paid. Under such a clause, SC1 steps aside, SC2 is paid first, and then SC3. SC1 is paid last, after SC3 – assuming there is enough money. If there is not, SC1 gets nothing. d. “Assigning” Priority It is possible for a creditor to assign his interests under the security agreement, but he cannot assign his priority rank. For example, SC1, SC2, and SC3 are each owed $100K. SC1 no longer wants to be a lender, and offers to assign his interest to SC3. If SC3 accepts, he becomes first in line for the purposes of SC1’s security agreement – but he remains third in line for the purposes of his own security agreement. He may not shift his $100K up the line. The way around this is for SC3 (acting as SC1) to make a loan to the grantor for the purpose of paying off SC3 as SC3. The grantor would have to agree to this. But would he? By the time a priority contest arises, the grantor is usually content to watch the bloodshed. If SC1 was entitled to future assets, this would extend to SC3 as well. 51 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH e. Priority between PPSA and Bank Act Security Rights Innovation Credit Union (Sask. C.A., 2009) Facts: 1991: Farmer granted a security interest in all of his present and after-acquired property to Innovation Credit Union o 1994: Credit Union registered its security interest 1998-2004: Bank of Montreal loaned farmer money on the same collateral, not knowing about Innovation Credit Union’s prior interest (the farmer did not disclose it) o Bank registered the security interest under s. 427 of the Bank Act 2004: Farmer defaulted on his loan payments Both creditors want the collateral Issue: Can the holder of a Bank Act security rely on a PPSA secured creditor’s failure to perfect its security interest? Holding: NO, unperfected PPSA security interest prevails Reasoning: Credit Union’s security interest was attached (though not perfected) o Therefore, the Credit Union acquired an enforceable proprietary right A bank holding security taken pursuant to the Bank Act cannot gain access to the PPSA priority regime, which provides that a perfected security interest takes priority over an unperfected one Bank Act provisions do not in themselves confer priority, except for s. 428(1), which accords priority to Bank Act security over “rights subsequently acquired” Therefore, according to nemo dat principle, the Bank acquired its interest in the collateral subject to the interest of the Credit Union The only salient point in this judgment is that the legislature has made its intention clear in denying the banks the benefit of the priority rules contained in the PPSA unless a security interest is taken under the PPSA Further Points Registration, in the context of the PPSA, does not serve the purpose of “notice to all”, except incidentally o Rather the purpose is to establish priorities by virtue of the time of registration, for the purposes of the PPSA only Law Reform Commission of Saskatchewan: Banks want their security interests to be treated as PPSA security interests, but this means that banks want to have the benefits of the PPSA without being bound by it Note: the reverse situation would be different: If you fail to register your Bank Act security interest, it is ineffective against any subsequent purchaser or mortgagee (including provincial mortgagees) “While the Banks’ counsel are justifiably concerned about a result that will lead to uncertainty in commercial law, this decision does not render the law uncertain.” 52 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH Radius Credit Union (Sask. C.A., 2009) Facts: Credit Union executed a security agreement on all present and after-acquired property, but did not perfect it Then, Royal Bank acquired a security interest in the after-acquired property under the Bank Act, and perfected it Issue: Can the holder of a Bank Act security rely on a PPSA secured creditor’s failure to perfect its security interest? Holding: NO, unperfected PPSA security interest prevails – date of execution of the respective security agreements is determinative, whether or not the PPSA interest is perfected Reasoning: As a matter of law, both security interests attached simultaneously, when the debtor acquired rights in the collateral o For the PPSA security interest, this is because the Credit Union had already given value and executed a security agreement before this point – see s. 12(1) NB, s. 11(2) Ont. o For the Bank Act, the legal reasoning of why the security agreement attached when the debtor acquired rights in the collateral is more complicated, but the result is the same Thus, nemo dat principle can’t resolve the issue The Bank Act does not contain a priority rule with respect to competing interests arising from security interests in after-acquired property Under the PPSA, a failure to register does not affect the validity, or the enforceability, of the interest (contrary to prior law) Court must “establish a priority rule where neither the statute law nor binding precedent has established one” Argument for a rule based on date of registration: o Greater certainty for banks loaning money in individual cases Argument for a rule based on date of execution of the agreement: o Goes against legislative intent in s. 4(k), which expressly declared that the PPSA does not apply to security interests created under the Bank Act – banks therefore cannot participate in the PPSA priority structure o Would make an already complex system more complex – better to have a simple, certain priority rule o There will be injustices either way – in this case, there is the fact that the Credit Union was the principal lender, and that the Bank did not lend the bulk of its money until after the Credit Union registered NOTE: LEAVE GRANTED TO APPEAL TO THE SCC – DECISION PENDING Would have been different under Quebec, since the only question is whether the bank would have counted as a third person, and it clearly is 53 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH VI. COMPETING CLAIMANTS: BUYERS Under the CCQ and PPSA, there are various circumstances in which a secured creditor may enforce his security right against a buyer. A. Secured Creditor’s droit de suite As per CCQ 2660, the droit de suite is one of the attributes of a hypothec. The droit de suite allows secured creditors to follow the asset, enabling them to assert their security right even when the asset is sold by the grantor. The PPSA grants a similar right in s. 25 ON (s. 28 NB), which stipulates that the security right continues after a sale, unless the secured creditor consented to a sale free of the security right. This is implicit in the CCQ as well (ie, if the secured creditor has given up his right to follow, the asset may be sold free of the right). B. Exceptions to the droit de suite 1. Failure to Publish/Perfect If the secured creditor fails to publish/perfect, then he may not exercise his droit de suite against a buyer. Note, however, that an unperfected security right may be asserted against a buyer with knowledge, as per the PPSA. 2. Authorized Sales As noted above, the secured creditor may not assert his droit de suite if he has authorized the asset to be sold free of his security right. 3. Sale in the Ordinary Course of Business The PPSA and CCQ differ as to whether the buyer takes free in a sale in the ordinary course of business, where the security right was issued not by the immediate seller/dealer, but by a predecessor in title. a. Sale in the Ordinary Course of Business in the PPSA Under the PPSA, the buyer does not take free. As per s. 28(1) (ON) and s. 30(2) (NB) He only takes free if the security right is granted by seller (ie, the person who is selling in the ordinary course of business). The only way for the buyer to discern the existence of a prior security interest would be to ask the dealer for the history (or to search by VIN if a road vehicle). The buyer has a remedy in K, since one of the implied terms of the K of sale is that the seller has a clean and unencumbered title. If the buyer is forced to satisfy the secured creditor, he may bring an action in K against the seller. There is always the risk that the seller is bankrupt or no longer in existence. Who should bear the risk here, the buyer or the secured creditor? They are both victims (recall that the secured creditor has not authorized the sale). It is more difficult for the buyer to check the registry than for the secured creditor to do so. In ON, legislation now imposes the search burden on sellers with respect to road vehicles. The seller is required to submit the most up-to-date search results to the buyer. 54 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH b. Sale in the Ordinary Course of Business in the CCQ i. Hypothecs Under the CCQ, the buyer does take free. There is no specific article that stipulates this, but it is implied by several articles that presume the buyer takes free of any hypothec in such sales. These include CCQ 2700, para 1, which states that unregistered movable hypothecs on property not sold in the ordinary course of business may nonetheless be preserved; CCQ 2732, which refers to the right to follow movable property not sold in the ordinary course of business; and CCQ 2674, which refers to a hypothec on a universality of property (inventory), stipulating that if inventory is sold in the ordinary course of business, the hypothec shifts to the new inventory. Each of these provisions points to an exception to the droit de suite for sales in the ordinary course of business. Without the exception, it would be impossible for anyone to sell inventory; consumers would never purchase inventory that was charged with a hypothec. ii. Non-hypothecary Security The title-based security devices may form the basis of the security right that encumbers the asset. In such a situation, both the grantor’s sale to the dealer (B1) and the dealer/seller’s sale to the ultimate buyer (B2) are sales of the property of another. Recall that in an instalment sale or sale with the right of redemption, the secured creditor is actually the owner. CCQ 1713-1715 governs sales of the property of another, and apply to sales in the ordinary course of business. As per CCQ 1713, a sale of the property of another by someone other than the owner is null, unless the seller becomes the owner. Thus, both sales here are null, unless the sellers pay off the secured creditor to acquire clean title. CCQ 1713 The sale of property by a person other than the owner or than a person charged with its sale or authorized to sell it may be declared null. The sale may not be declared null, however, if the seller becomes the owner of the property. CCQ 1714 allows the secured creditor to revendicate, but he must reimburse the buyer (B2) who has purchased the asset in good faith in the ordinary course of business. This is a large disincentive for the secured creditor; effectively, B2 is getting good title. Also note that the right of revendication applies to every transaction in the chain. CCQ 1714 The true owner may apply for the annulment of the sale and revendicate the sold property from the buyer unless the sale was made under judicial authority or unless the buyer can set up positive prescription. If the property is a movable sold in the ordinary course of business of an enterprise, the owner is bound to reimburse the buyer in good faith for the price he has paid. c. Remedies for Sale in the Ordinary Course of Business B1 (the seller/dealer) is liable to whoever suffers the loss – the hypothecary seller or instalment seller under the CCQ, and B2 under the PPSA. The basis of B1’s liability would probably be unjust enrichment. He should have determined whether the asset was encumbered before selling it on. 55 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH 4. Serial Numbered Goods Under the PPSA, the buyer takes free if the serial number should have been registered but was not (equipment, consumer goods, and inventory). Ontario system is of of no assistance in the very situation that serial number registration was instituted to address: that is, where a seller up the chain of sale takes a security interest (since the law only covers the last sale) Under the CCQ, the situation is more ambiguous. Inclusion of the serial number seems to be a requirement of publication (“descriptive file”). 5. Low Value Goods The NB PPSA (s. 30(3)) allows the buyer to take free on all consumer goods with a value of $1000 or less, whether the sale was in the ordinary course of business or any other kind of sale. The provision is intended to capture yard sales and garage sales. However, since a secured creditor is unlikely to follow such low value assets, the provision has little practical significance. There is no equivalent in the ON PPSA. VII. COMPETING CLAIMANTS: UNSECURED CREDITORS AND NON-CONSENSUAL SECURED CREDITORS The CCQ has a comprehensive legal framework with respect to unsecured and non-consensual secured creditors. In contrast, the law in other provinces is fragmented, arising from various statutes and jurisprudence. A. Prior Claims and Legal Hypothecs in the CCQ 1. Prior Claims As per CCQ 2644, all of a debtor’s property is available to satisfy his creditors (creditors’ common pledge). CCQ 2645 stipulates that property is similarly charged for the performance of personal obligations. CCQ 2646 allows creditors to go to court to actually obtain the property, and notes that some of them will have a “legal cause of preference” against others. CCQ 2647 defines these legal causes of preference as hypothecs and prior claims. A prior claim is right of priority. It is good only against the debtor; it is not a property interest, so it cannot be asserted against third parties like a security right. Thus, as per CCQ 2655, prior claims may be set up against other creditors without publication (even where the prior claim is a real right see CCQ 2654.1 below). CCQ 2651 lists the prior claims in their order of priority (as per CCQ 2657, they rank in this order amongst themselves if there is more than one claim in a single category, they share proportionally). CCQ 2651 The following are the prior claims and, notwithstanding any agreement to the contrary, they are in all cases collocated in the order here set out: (1) legal costs and all expenses incurred in the common interest; 56 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH (2) the claim of a vendor who has not been paid the price of a movable sold to a natural person who does not operate an enterprise [ie, a consumer sale by a vendor]; (3) the claims of persons having the right to retain movable property, provided the right subsists [ie, a repairer’s lien, which allows him to retain possession until payment is rendered]; (4) claims of the State for amounts due under fiscal laws; (5) claims of municipalities and school boards for property taxes on taxable immovables as well as claims of municipalities, specially provided for by laws applicable to them, for taxes other than property taxes on immovables and movables in respect of which the taxes are due. None of the above are real rights except for the final category (5), property taxes. Here, as per CCQ 2654.1, the property taxes constitute a real right, and confer upon the holder of the claim the right to follow the taxable property. Although a real right, such a prior claim need not be published to be set up against third persons. As per CCQ 2650, prior claims outrank every other claim, even hypothecs. There is no point in registering them, because they always rank first. The implication of arts. 2654.1 and 2655 is that a prior claim is not a real right (except for municipalities) – it’s just a personal right, only good against the debtor, and doesn’t follow the property (except for municipalities) The prior claim ceases when the underlying obligation is extinguished, as per CCQ 2659. 2. Legal Hypothecs Legal hypothecs are hypothecs created by operation of law rather than the consent of the parties. They are defined in CCQ 2724. Only the following claims may give rise to a legal hypothec: CCQ 2724 (1) claims of the State for sums due under fiscal laws, and certain other claims of the State or of legal persons established in the public interest, under specific provision of law [ie, this overlaps with prior claimants – the State can be both a prior claimant and hold a legal hypothec, and the registration of the latter does not prevent the State from exercising the former (CCQ 2725 para 3)]; (2) claims of persons having taken part in the construction or renovation of an immovable; (3) the claim of a syndicate of co-owners for payment of the common expenses and contributions to the contingency fund [ie, if one of the condo tenants refuses to contribute]; (4) claims under a judgment. CCQ 2725 stipulates that legal hypothecs of the State may attach to movable or immovable property, and take effect from their registration in the proper register. Registration is therefore required for creation, not merely for third party effectiveness. 57 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH For immovables, they are registered against a specific plot For movable property, they may encompass present and future assets. CCQ 2726: there are separate provisions for legal hypothecs for builders. These exist only in respect of the specific immovable Need not be published to exist. The legal hypothec arises automatically upon completion of the work. It lasts for thirty days after the completion of the work (CCQ 2727); to preserve it, the legal hypothec must be registered within the thirty days. Unless a claim is made against the owner, it will expire within six months. As per CCQ 2728, the hypothec secures the increase in value added to the immovable by the builder’s work (for sub-Kors, the hypothec is limited to the work supplied after the written declaration of the K to the owner it only covers work to which the owner has consented). For legal hypothecs related to condo fees, CCQ 2729 states that the legal hypothec comes into existence when registered. The amount registered may include the current amount owed, and plus the anticipated arrears for that year and the next two years. The defaulting co-owner’s fraction is charged. A judgment creditor may acquire a legal hypothec on the movable or immovable property of his debtor, as per CCQ 2730. He must register a notice describing the charged property and the amount of the obligation, along with a copy of the judgment. The notice must be served on the debtor. BUT NOTE THAT ANY JUDGMENT CREDITOR WHO HAS NOT EXERCISED HIS RIGHT BEFORE THE DEBTOR GOES BANKRUPT BECOMES AN UNSECURED CREDITOR (s. 69 BIA) CCQ 2731 essentially allows the court to determine that the holder of a legal hypothec is over-secured, and that the legal hypothec may be cancelled or reduced. This cannot be done where the legal hypothec is held by the State. CCQ 2732 confirms that legal hypothecs have a droit de suite, just like conventional hypothecs. Advantages for the holder (the state) Disadvantages for the holder (the state) B. Prior Claim Super-priority, even over hypotheques No need to register No droit de suite No special enforcement remedies available to hypothecary creditors Legal Hypotheque Droit de suite Special enforcement remedies available to hypothecary creditors Rank behind a superpriority, as well as potentially many other hypothecs Need to register Judgment Creditors in the PPSA N.B.: A judgment creditors must: Register (2.2(1), 2.3(1), 2.3(9)) NB Creditor’s Relief Act If he wants to be protected against being subordinated to further advances made by a higherranking secured creditor, he must send notice to any higher-ranking secured creditor (35(6)(b) NB PPSA) 58 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH Once registered, the judgment thus functions like a security right in present and future personal property. Priority is determined by order of registration. The PPSA uses the time of seizure to determine priority between judgement creditors and other secured creditors. An unperfected security interest is subordinate to the interest of a judgment creditor who has seized the collateral (s. 20). Ontario: No provision made for registration – judgment creditor only has priority when he actually seizes the asset (implied that there is no other way in s. 20(1)(a)(ii) No priority over perfected secured creditors, however BUT NOTE THAT ANY JUDGMENT CREDITOR WHO HAS NOT EXERCISED HIS RIGHT BEFORE THE DEBTOR GOES BANKRUPT BECOMES AN UNSECURED CREDITOR (s. 69 BIA) C. Special Priority Rules for Construction Suppliers 1. Construction Suppliers’ Priority in the CCQ As per CCQ 2952, legal hypothecs held by those who have constructed or renovated a movable outrank all other published hypothecs. 2. Construction Suppliers’ Priority in the Common Law The ON Construction Lien Act is a far more nuanced approach. It is intended to protect those who build immovables, particularly sub-Kors. Their Contractual relationship is with the general Kor, not the owner of the immovable. If the general Kor fails to pay them, they cannot take a security interest in the immovable, because they have no Contractual relationship with the owner. The law therefore gives them a lien against the immovable. This is an incentive for the owner to ensure the general Kor pays what he owes. The Act assumes that each of the sub-Kors has contributed enough to add to the value of the immovable. The secured creditor has loaned money to the owner based on the immovable’s value; but because he is financing the construction, the amount tends to increase over the existing value (eg, building mortgage, where the secured creditor is paying the owner to enable to sub-Kors to purchase materials, etc). In this situation, s. 78 of the Act tries to ensure that neither the secured creditor nor the sub-Kors are prejudiced if the owner fails to meet his obligations. D. Impact of Federal Bankruptcy Legislation on Priorities Three main effects: Downgrades most Crown claims (86, 87) Reduces judgment creditors to the status of unsecured creditors (69,70(1)) Creates new categories of superpriority (feed suppliers, etc. (95, 81.1-81.4)) Priority is determined by provincial law, whereas bankruptcy and insolvency are governed by federal law (the federal Bankruptcy and Insolvency Act). In theory, therefore, bankruptcy and insolvency should have no impact on priority. 59 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH Under the PPSA, perfection of the security right is a precondition of effectiveness against the trustee in bankruptcy Here, the provincial law is addressing itself to the federal issue of bankruptcy Giffen affirmed this rule (ie, perfection is a precondition of effectiveness against a trustee) o The court in Giffen held that although provincial law was the source of the property right, it could properly impose this requirement in relation to the federal law Thus, the secured creditor must register before the date of the bankruptcy (as defined in the Act) in order for his security right to survive the bankruptcy proceedings. Contrast this with the CCQ, where publication is required for effectiveness against all third persons – and where third persons was traditionally assumed to include the trustee in bankruptcy If the secured creditor did not publish prior to the bankruptcy, he could not assert his right against the trustee, and the asset went to the estate Ouellette and Lefebvre have cast doubt on this position, however, since both held that the trustee is not a third person o Since the trustee has the rights of the grantor, and publication is not necessary for effectiveness between the parties, publication is also unnecessary for effectiveness against the trustee. Although neither Ouellette nor Giffen dealt with hypothecs, the courts’ reasoning could be extended to hypothecs as well Although the decisions emphasized the difference between hypothecs and retention of title agreements, the distinction makes no sense o If the trustee is not a third person for the purposes of CCQ 1745 (instalment sales) why is he a third person in CCQ 2667 (hypothecs)? The federal Act seeks to make registration a precondition for effectiveness against a trustee acting for unsecured creditors. Why is this, since unsecured creditors do not rely on publicity? o For policy reasons. 1. It encourages registration in general Unsecured creditors do not rely on publication, but they do rely on credit agencies, and the credit agencies rely on registry searches for their credit assessments 2. In the event of a bankruptcy, registration enables the trustee to identify the secured creditors in an efficient way. This allows him to easily calculate the amount that will be left over for unsecured creditors. Under the BIA, the super priority of prior claims and legally hypothecs of the State does not apply s. 86) Contrast with the CCQ, where fiscal claims of the State are prior claims. There are three exceptions to the rule that Crown claims are unsecured claims (s. 87). 1. the Crown claims a right available to any other person (ie, the Crown takes a hypothec like anyone else) 2. the Crown exercises its statutory attachment remedy with respect to income tax, CPP, employment insurance (ie, these required deductions are exempt from the rule the Crown may claim this amount in a prior claim, legal hypothec, etc) 3. the Crown registers its non-consensual security right with respect to deductions owing but the Crown’s security is limited to the amount owing at the time of registration; the Crown may not register against future arrears the Crown also ranks behind any other previously registered security interest the super priority is therefore limited to the amount that is actually in arrears, and only if it is registered 60 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH Arguments for the BIA’s limitation of the Crown’s superpriority! If the first secured creditor (ie, the bank that lent to the business) were to face an unknown level of future super priority by the Crown, it would chill access to credit. o Walsh: not very convincing As long as the bank knows how much of the asset-base will go to the Crown, the bank can plan accordingly Splits the burden of monitoring the debtor’s financial health between the bank and the Crown – less onerous than putting all the responsibility on the bank Arguments against the BIA’s limitation of the Crown’s superpriority! Gives banks a huge incentive to draw out proceedings so as to force the situation into bankruptcy (also because this eliminates the competition of judgment creditors who have not yet executed) o Goes against idea of having proceedings be neat and orderly Neatness and orderliness also suffers from the general rule of having insolvency invert priority Section 136 of the Act sets forth the basic distribution scheme followed by the trustee. Secured creditors’ obligations are satisfied off the top, and only then are the others satisfied. If the secured creditors swallow the value of the estate, the others get nothing. Secured creditors include those with the right of retention, or a prior claim constituting a real right (ie, municipal property tax). Consensual and non-consensual security rights are included; those exercising a construction lien, or a right in unpaid condo fees, are secured creditors for the purposes of the Act. After secured creditors come: o Preferred creditors Include landlords, employees to the extent of $2000, and others. Preferred creditors are bound by their classification under the Act, even where provincial law would accord them super priority, or treat them as a secured creditor (eg, employees are secured creditors under provincial law, but because the Act classifies them as preferred creditors, they rank behind secured creditors for bankruptcy purposes). o General creditors o Deferred creditors Section 69 and 70 of the Act freezes all enforcement rights of creditors under provincial law, upon commencement of bankruptcy proceedings. This includes judgment creditors, because exercising a judgment is interpreted as an enforcement mechanism. Judgment creditors are not secured creditors for the purposes of the Act. While exercising a judgment normally allows a creditor to convert from unsecured to secured status, this does work in bankruptcy situations. Because all unsecured creditors are supposed to share pari passu, it is considered unfair to elevate some unsecured creditors simply because they obtained a judgment. On the other hand, eliminating judgment creditors from the pool of secured creditors might create a windfall for the remaining secured creditors. Section 81.1 of the Act gives a right of reclamation to unpaid suppliers of inventory, to be exercised within 30 days of the bankruptcy. This right of reclamation is granted a super priority. However, it is hemmed in by so many procedural constraints that very few suppliers exercise it. Also note that it can only be exercised if the bankruptcy is a liquidation, not a reorganization. Section 81.2 of the Act grants an equivalent right to suppliers of perishable goods to farmers, fishers, and aquaculturalists (eg, feed, growth hormone, etc). Should the farmer go bankrupt, the supplier may assert a security right over his inventory, to the extent of his contribution, within the same 30 day window. This is also a superpriority, and is unused for the same reasons of inefficiency. 61 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH 69-69.3: These three sections provide for a stay of enforcement proceedings by creditors on (1) the filing of a notice of intention to file a reorganization proposal (s. 69); (2) the filing of a reorganization proposal (s. 69.1); (3) the bankruptcy of the debtor (s. 69.3). Unlike in the case of a stay in respect of pending or still ongoing reorganization proceedings under sections 69 and 69. 1, a stay in the case of bankruptcy under s. 69.3 does not stay enforcement by secured creditors - see s. 69.3(2). VIII. ENFORCEMENT OF SECURITY ON DEFAULT The creditor exercises enforcement measures when the debtor is in default. The default may occur by virtue of bankruptcy, or it may be a default to one creditor. The unsecured creditor is owed a personal obligation, while the secured creditor actually has a proprietary right. Because of this, the law tries to ensure that the enforcement options available to a secured creditor are efficient. There are also safeguards against appropriate of excess value by the secured creditor. The secured creditor is not entitled to the asset itself, but to its value. a. Enforcement in the CCQ The CCQ allows creditors to exercise their personal and hypothecary rights against the debtor in CCQ 2748. The creditor may only exercise his hypothecary rights in addition to his personal ones; he may not add more rights through the security agreement. CCQ 2748 outlines default as the failure to pay, or anything that is defined as default by the security agreement. This means default is quite elastic. CCQ 2748 also says the claim must be liquid and exigible (ie, the parties must know how much is owed, and it must be owed now). On its face, enforcement in Chapter V of Book VI of the CCQ only applies to hypothecary creditors. However, recall that the title-based security devices assimilate the hypothecary enforcement mechanisms (eg, instalment sales, sales with the right of redemption, trusts). There is no enforcement assimilation for leases/leasing; they must be published for third party effectiveness, but the lessor’s remedies are not those of a hypothecary creditor. This creates a loophole, because someone could set up an instalment sale as a lease to try and avoid the hypothecary enforcement mechanism. CCQ 1801 says that no clause, for the purpose of securing performance of the debtor’s obligation, may turn a secured creditor into an owner (although the title-based security devices do exactly this). The article prevents creditors from manipulating title to evade the hypothecary procedures. In practice, however, a court would probably treat the impugned transaction as whatever it most closely resembles (ie, sale and leaseback resembles a sale with the right of redemption, but seems to violate CCQ 1801; it functions like a security right rather than a lease, but has tax advantages; courts would treat it like a sale with the right of redemption, rather than using 1801 to nullify it). b. Enforcement in the PPSA The PPSA is functional, and applies to all transactions that create a security right, irrespective of form. However, recall that certain transactions are deemed to create a security interest when they do not actually do so (eg, operating lease for a term of greater than one year, commercial consignment, etc). These are nonetheless included in the PPSA for publicity reasons. The PPSA’s enforcement measures (Part V) do not apply to deemed security transactions. The PPSA does not say the claim must be liquid and exigible, but this is inherent. In both the PPSA and CCQ, the secured creditor who enforces where there is no actual default is liable in K and tort. So 62 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH although the definition of default may be elastic, secured creditor’s will not risk enforcing on some technical point. The creditor may exercise his enforcement rights as a secured creditor, and any rights he has under the security agreement (ON 59(1), NB 56(2)). Contrast this with CCQ 2748. However, the security agreement cannot be used to K out of the enforcement rights in Part V. The debtor may be given more rights, or the secured creditor may K out of things to which he is entitled – but the rights of the debtor may not be reduced. A. Preliminary Remedies 1. Surrender/Seizure The most obvious preliminary remedy is to take possession of the charged asset in order to sell it. This may be through seizure, or the debtor may hand it over voluntarily. a. Surrender in the CCQ As per CCQ 2763, surrender may be voluntary or forced. As per CCQ 2764, voluntary surrender is when the debtor hands over the asset during the advance notice period, or consents to hand it over in writing. Forced surrender is defined in CCQ 2765 as surrender ordered by the court after ascertaining the existence of the claim, default, the debtor’s refusal to surrender the asset voluntarily, and the absence of a valid cause for objection. Surrender may also be forced where the court orders the surrender of the property before the notice period has expired, if the collateral is perishable and will diminish in value (CCQ 2767). b. Seizure in the PPSA Upon default, the secured creditor may take possession by any method permitted by law (ON 62, NB 58(2)). This includes the tradition of “peaceable recaption” at common law: if the creditor can recapture the asset without breaching the peace, he may do so, even if he lacks the debtor’s consent. This may include the use of false representations, but may not include violence, the threat of violence, or the possibility of the debtor becoming violent. 2. Sale In order to realize the value of the asset, the secured creditor will usually effect a sale. If the proceeds of the sale exceed the value of the obligation, the surplus is returned to the grantor; he is entitled to the asset’s residual value. The biggest concern with sale is that the secured creditor will sell to the first person to offer him the amount he is owed, even if the asset is worth more. There are safeguards to ensure that the secured creditor obtains the maximum possible amount. a. Sale in the CCQ The sale may be effected by the creditor himself, as per CCQ 2784, via tender or public auction. Some assets will realize better value through different methods. As per CCQ 2785, the debtor must sell without unnecessary delay, at a reasonable price, and in the best interests of the debtor. The sale may be effected by judicial authority as per CCQ 2791. The court designates all the details of the sale. This is the method most commonly used, because it purges competing real rights. As per CCQ 2790, the purchaser in a sale takes the property subject to the security interests ranking below those of 63 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH the seller (ie, if SC1 sells, the buyer takes subject to SC2’s right). In a sale by judicial authority, the buyer takes free and clear, and the court distributes the proceeds amongst the creditors according to priority. This complete purge is good for the marketability of the property. As per CCQ 2792, no creditor can require the sale to be subject to his own hypothec in sales by judicial authority. CCQ provisions for sale by the creditor himself are almost unusable if there are more obligations than there is value in the assets. Heavy incentive for creditors to use the judicially-directed sale Why this incentive? o Partly because the CCQ in general likes judicial oversight o Partly because CCQ is also talking about real property in all these instances – need to be more careful o Partly for the good reason that the SC doesn’t have an interest in selling the asset for any more money than the money he is owed True, there is the obligation of “commercially reasonable means”, but this requires the secured debtor to go to court ex post facto, when presumably he is pretty tight on cash b. Sale in the PPSA Under the PPSA, a purchaser takes free of the claims of the enforcing secured creditor and claims subordinate to his, but subject to prior claims (ie, if SC2 enforces, the purchaser takes free of his claim but subject to that of SC1). This means that the purchaser will ask for a huge discount, and SC1 and SC2 will agree that SC1 should enforce, or the purchaser will settle with SC1. This rule does not promote marketability. Sale is set out in s. 63(2) (ON) and s. 65 (NB) (also see s. 63 ON and s. 59 NB). Sale is always by the creditor, not by judicial authority. The creditor has complete discretion over the time/manner of the sale, but also faces certain constraints. He must inform the other secured creditors and the debtors of the sale (the PPSA says that only subordinate creditors must be informed, but in practice, all are informed). He is also bound by good faith and commercial reasonableness – but given the costs of litigation, how likely is he to be challenged? Walsh: the deficiency is that SC2 doesn’t have to notify SC1, because the assumption is that SC1 can follow the asset into the hands of the purchaser SC1 will want to know, so it can come in to enforce itself if it wants to Also, SC1 will probably want to stop lending money to the grantor Also: could be clumsy and difficult to trace this asset through the hands of one or more purchasers In practice, though, SC2 WILL notify SC1, because he knows that he won’t get maximum value selling an asset subject to a security agreement The purchaser knows that they are taking subject to a security interest, so they won’t pay much for it 64 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH 3. Taking in Payment Rather than selling the asset, the secured creditor may wish to take it in payment. The grantor might also prefer this Especially if the asset’s current market value is less than the amount he owes Or if he is being pursued by multiple secured creditors, and wishes to make a quick getaway. However, if the value of the asset is higher than the value of the obligation, taking in payment seems akin to unjust enrichment. On the other hand, taking in payment can be an efficient remedy under certain circumstances (eg, if the secured creditor is a vendor of collateral of the same kind taking in payment would work well here). The problem with taking in payment is that it seems to be the manipulation of title to make the secured creditor the owner – exactly what CCQ 1801 and equity attempt to restrain. In both the CCQ and PPSA, the secured creditor must give advanced notice of his intention to take in payment. At the end of the notice period, title passes, unless there is an objection by the debtor or one of the other secured creditors. If there is an objection, the enforcing creditor reverts to a sale. An objection would be linked to the unjust enrichment concern (ie, the value of the collateral exceeds the value of the obligation, and the debtor wants to force a sale to have the surplus returned). Under the PPSA, one simply objects; but the secured creditor may go to court and say the objection is frivolous. Under CCQ 2779 para 1, the person objecting must register a notice of his objection, pay the expenses of the sale, and reimburse the creditor for money already spent. This is meant to discourage frivolous objections. However, the grantor at this stage is already broke. How does forcing him to pay more money help the system? Under the CCQ, the grantor and subordinate creditors must spend money at the outset. Under the PPSA, the grantor and subordinate creditors may be responsible for costs after the judgment, but there is no initial outlay. This is a rare instance of the CCQ being more protective of the secured creditor than the PPSA. 4. Collection of Accounts Recall that accounts are intangible receivables. Because receivables are already expressed in monetary terms, there is no risk that the seller will fail to realize their market value. Rather than selling the receivables, however, an easier option would be to simply collect them. Secured creditors may collect receivables directly by giving notice to the debtors. Once the obligation is realized, the secured creditor ceases to collect and remits any excess to the grantor. a. Collection of Claims in the CCQ In the CCQ, collection of claims is not found with the other hypothecary remedies, but at CCQ 2743-2747, immediately preceding Book V. The provisions contemplate the creditor’s right to collect claims from the moment the hypothecary agreement is entered into, rather than at the time of default. If the creditor has a 65 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH hypothec on claims, he may collect from the outset, or authorize the grantor to do so on his behalf. The authorization may be withdrawn, but the withdrawal must be registered, and the debtor informed (ie, notice). Any excess between what the grantor owes and what the secured creditor collects reverts to the grantor. Beyond registering the withdrawal of authorization, the CCQ does not impose an advance notice requirement here. It is a claim, so there is no concern regarding valuation. b. Collection of Claims in the PPSA Under the PPSA, the secured creditor may collect upon default, or beforehand if the parties agree. 5. Receivership and Administration of the Property of Another a. Receivership in the Common Law If the secured creditor’s right pertains to present and after-acquired property, he may wish to keep the business going in order to sell it as a going concern. This is what a bankruptcy reorganization is intended to accomplish. Outside the bankruptcy context, receivership allows the secured creditor to reserve the right (under the security agreement) to appoint a receiver to manage the business until he finds a good buyer, or simply to manage it for a temporary period. Equitable receivership refers to the situation where the secured creditor does not rely on the security agreement, but seeks the right of receivership from a court. Receivership tends to occur in the context of a bankruptcy reorganization. The receiver is an agent of the debtor, although appointed by the secured creditor, the idea being to shield the secured creditor from liability if the business is mismanaged. Nowadays, however, courts are likely to say that such clauses will not shield the secured creditor from liability. b. Administration of the Property of Another in the Civil Law Contrast receivership with the administration of the property of another, which is a more general civil law remedy available upon application to the court. There are very strict duties associated with this, and it imposes the same liabilities as those of a trustee (in contrast to receivership, which tries to shield the secured creditor from liability). Because it is so onerous, it is rarely used. 66 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH B. Rights of Grantor and Third Parties 1. Advance Notice The grantor and third parties have the right to advance notice of enforcement action. This enables them to monitor the enforcement proceeding to ensure their interests are protected. There is a risk that advanced notice will prompt the grantor to hide/secrete the asset. If the items are perishable, too much advanced notice might mean the items are valueless by the time the secured creditor gets them. The advanced notice requirement is closely linked to the grantor’s right of redemption: his right to recover the asset by paying the secured creditor. Giving the grantor this last chance to reclaim title is a very important element of the advanced notice requirement. a. Advance Notice in the CCQ As per CCQ 2748, creditors may not enforce their hypothecary rights until the period for the surrender of property in CCQ 2758 has expired (20 days for movables, 60 days for immovables, 30 days for movables under a consumer K). This period starts to run after registration of the notice, as per CCQ 2757: the creditor prepares a notice, registers it, and serves it on the debtor. Here, registration also provides evidence that the notice has been served. The notice must name the event of default, state the amount of claim, and state the nature of the right the creditor intends to enforce. CCQ 2759 allows a dealer in securities to sell shares without prior notice. Even though the hypothec has already been published, advance notice must be registered. Registration is a pre-condition of enforcement. This is because the Registrar forwards the notice to everyone else holding a registered right against that grantor, or that parcel of land. The notice thus serves as a warning to all the others. b. Advance Notice in the PPSA Because the common law allows peaceable recaption, the PPSA does not impose an advance notice requirement to take possession. Advance notice is required for sale and taking in payment, however. Creditors may take possession once the grantor is in default, without advance notice; but they must then send notice of the sale/taking in payment to the debtor and other secured creditors. The ability of creditors to take possession without advance notice is slightly ambiguous, because the traditional of advance notice is so ingrained in the common law. The NB PPSA cross-references the common law requirement. The ON PPSA does not. However, the federal Bankruptcy and Insolvency Act now imposes a 10-day advance notice requirement if the creditor is proceeding against business assets, so the issue is largely moot. Note that the burden of informing the others is placed on the enforcing secured creditor (contrast this with the CCQ, where the Registrar is responsible). 67 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH C. Impact of Bankruptcy/Insolvency on Enforcement Rights Historically, the purpose of bankruptcy was to liquidate and distribute the proceeds, subject to the rights of secured creditors – it was not to reorganize. There was an automatic stay for judgment creditors, but not secured creditors; the trustee had no control over the secured creditors, who were free to use remedies accorded by provincial law. After the 1992 reform of the Bankruptcy and Insolvency Act, reorganization became an equal method (alongside liquidation). If there is a reorganization, there is now an automatic stay for secured and unsecured creditors, so secured creditors may not exercise their remedies under provincial law. Section 243 imposes a 10 day advance notice requirement for secured creditors who wish to enforce against business assets, so that the debtor has time to create a proposal for reorganization. The stay is continuously extended until the proposal is accepted. If it is rejected, the debtor is automatically in liquidation. If there is a surplus following the liquidation, the secured creditors give it back to the trustee. 2. Redemption and Reinstatement [See Legislation Quicksheet] IX. CONFLICT OF LAWS In the vast majority of cases, publication occurs through registration. But where should the creditor register if the assets are in different locations, or the debtor has different offices? These questions are covered by CCQ 3102-3106; and ss. 5-8 of the PPSAs. With respect to immovables, the law of the location of the land (lex situs) governs. With respect to tangible movables, the situs of the asset governs (eg, if Company X in Québec grants security in inventory located in all provinces, several states, and overseas countries, the secured creditor will have to register in each jurisdiction where the inventory is located, as per the laws of that jurisdiction). With respect to intangible movables, the situs of the grantor governs (eg, if Company X in Québec grants security in receivables from customers in California, China, and Africa, the secured creditor registers once in Québec). For mobile goods that are used in more than one jurisdiction (eg, trailers, vehicles, aircraft), there is some creepage between the categories. Because they are constantly in motion, the situs of the asset does not apply. Therefore, the situs of the grantor governs for mobile goods. There is also creepage the other way, for tangible obligations (eg, cheques, promissory notes, title documents). For tangible obligations such as these, the situs of the asset governs. The above rules necessitate that the location of the grantor be known. The CCQ stipulates that the location of the grantor is the “legal seat” of the corporation: the location of its registered head office. The registered office may be completely removed from the center of adminstration, or “real seat,” raising the question of whether this is right: should companies be able to choose the jurisdiction of a random place that is unrelated to their actual operation? The PPSA stipulates that the location of the grantor is its “real seat.” In practice, creditors tend to file in both places: the legal and real seats. 68 SECURED TRANSACTIONS – FALL 2007 – PROFESSOR CATHERINE WALSH The CCQ gives creditors 30 days to publish their security interest under the laws of the country for where the movable is destined (ie, publication takes effect only if the property reaches the country within thirty days of the creation of the security). The PPSA gives sixty days. 69
