Canada: Fully Secured @ Gowlings - July 14, 2010

Last Updated: July 28 2010

Edited by Richard Dusome

  • Ontario PPSA Computer Overhaul Still in the Works
  • Points to Consider when Taking Security on Assets in Québec
  • Proposed Amendments to British Columbia PPSA "Location of Debtor" Rules
  • To Register or Not to Register:
    Perfecting Your Security Interest over Limited Partnership Units in Ontario
  • Setting Aside a Borrower's Unauthorized Amalgamation
  • A Banker Asked Us:
  • Spotlight On Security Documents:

Ontario PPSA Computer Overhaul Still in the Works
By: Richard Dusome

You may recall that a number of amendments were made to the Ontario PPSA effective back on August 1, 2007. One of those changes involved the repeal of the "Check the Box" system used on Financing Statements to identify the collateral charged by a registration, and its replacement with a system requiring full collateral description narratives. It was initially intended that the change would be deferred or delayed for a period of one to two years to give the Ontario Ministry time to revamp its computer system to handle full collateral description narratives instead of the boxes.

Well, the anticipated two year deferral period passed without incident, and so far as we are aware from our discussions with Ministry officials, the change-over is still not on the horizon. It would appear that the computer overhaul is one more victim of the recession, with the expense of new computer hardware and software simply not being a priority for the provincial government at this time. We will continue to monitor this change and report any developments in future issues.

Points to Consider when Taking Security on Assets in Québec
By: Pierre-André Hamel

The Province of Québec has a civil law legal system which is unique in Canada. There are several points that a lender should know when acting on a cross-border or multi-jurisdiction financing that requires taking security on assets located in Québec. A "security interest" under common law does not constitute valid security under Québec civil law. It is therefore not possible to make a filing on the basis of a security agreement executed in accordance with the U.S. Uniform Commercial Code or the Personal Property Security Act of a Canadian Province. The instrument to take security on assets under the Civil Code of Québec is called a hypothec. A hypothec can affect immovable (real) property, movable (personal) property or both. A movable hypothec can be created with or without delivery of the hypothecated property. A hypothec created with delivery may also be called a pledge.

The Civil Code of Québec ("CCQ") provides that a movable hypothec without delivery must be granted in writing to be effective. In certain circumstances, execution of an agreement in private writing is not sufficient. The CCQ requires that a hypothec be created by notarial act "en minute" if (i) the hypothec affects immovable property and (ii) the hypothec is granted on movable and/or immovable property in the context of a syndicated loan where a secured party holds the security as agent or under power of attorney for the lenders. In these cases, the hypothec must be created in the deed executed by the parties before a Québec notary. The Québec notary is a legal practitioner, having a practice similar to that of a solicitor, who also has the authority to give authentic value to deeds signed by the parties before him/her.

Unlike a security agreement creating a security interest in other jurisdictions, a deed or agreement creating the hypothec must indicate the specific sum in Canadian dollars for which the hypothec is granted. The interest rate must also be expressed. This sum generally corresponds to the maximum amount of the indebtedness. However, since a hypothec is an accessory to the obligations it secures, the hypothec can only be enforced for the amount owed at the time of enforcement.

Like a security agreement in other jurisdictions, a hypothec has to be registered in order to acquire enforceability and ranking against third parties, but it is not possible to register in advance of the execution of the document creating the hypothec except in certain limited circumstances. Given the particularities of Québec law, deeds or agreements of hypothec need to be executed and registrations need to be completed in advance of closing if the lender or lenders want to fund upon execution of the main loan documents.

Also, in the case of a syndicated loan or loan secured by hypothec on immovable property where the hypothec has to be created by notarial deed, it is a requirement that representatives of the lender or secured party sign in the presence of the notary. If the lender or secured party has no representatives in the Province of Québec, it is general practice to have special representatives in the Province appointed for the execution of the documents, instead of having the representatives of the lender or secured party or the notary travel for execution. While these particularities of the Québec security regime are very different from those of other jurisdictions, they should not delay the closing on a financing provided that parties take these preparatory steps in advance to address the presence of assets in the Province of Québec.

Proposed Amendments to British Columbia PPSA "Location of Debtor" Rules
By: Linda Kwak

If a borrower has multiple business locations in different jurisdictions, it is not always clear where the lender should register its security interest. Under the British Columbia PPSA, the place where the borrower's "chief executive office" is located is the jurisdiction in which to register a security interest in intangibles (e.g. accounts), 'mobile' goods and investment property, and a non-possessory security interest in certain types of collateral. The term "chief executive office", however, is not defined; it is generally viewed as the location from which the borrower manages the main part of its business operations or other affairs and the location at which significant corporate planning and decisions are made. The facts pertaining to the borrower may not point to one location as the obvious "chief executive office" and, in such circumstances, the lender is often advised to register in all potentially applicable jurisdictions.

In B.C., amendments to the PPSA to change the "location of debtor" rules have been passed but have not yet come into force. The new rules will provide clearer references to determine where to register (based generally on the jurisdiction of incorporation or organization of the borrower); and in most cases, will eliminate the need to determine the location of the "chief executive office". These new rules will help to cut down on registration costs, as well as costs relating to legal fees and the maintenance of multiple registrations.

We have been advised that the proposed amendments are expected to come into force in B.C. in the fall of 2010 but we anticipate that the timing may be delayed in order to coordinate with Ontario and other provinces where similar amendments have been passed but are also not yet in force. A lender will have five years from the date the amendments come into force to re-perfect a registration that does not comply with the new rules. If a registration expires before the five year period, the lender will not need to re-perfect to comply with the new rules unless it proposes to renew its registration beyond the five year period. We will provide further updates through this newsletter. Should you have any specific questions as to how your registrations might be affected, please do not hesitate to contact us.

To Register or Not to Register:
Perfecting Your Security Interest over Limited Partnership Units in Ontario

By: Christine Mason

How can a lender whose loans are secured by a pledge of certificated limited partnership units perfect its security interest in Ontario?

The application, or non-application, as the case may be, of the Securities Transfer Act 2006 (Ontario) ("STA") to the limited partnership units will determine if the lender must perfect its security interest by delivery and control of the unit certificates, or by registering a financing statement under the Ontario PPSA.

The predicament for lenders is, that while some limited partnership units are governed by the STA, others are not. Unlike shares in a corporation, a limited partnership unit is not inherently considered to be a "security" under the STA. Instead, a limited partnership unit is only a security covered by the STA if the units are publicly traded or constitute mutual funds, or if the corresponding limited partnership agreement expressly provides that it is a "security" for the purposes of the STA. If the limited partnership agreement is silent on this point (as many are), then perfection of security interests in units of a private limited partnership is not governed by the STA. Rather, those units constitute "intangibles" governed by the Ontario PPSA.

For limited partnership units falling within the definition of a "security" covered by the STA, a lender must perfect its security interest over those partnership units by control of the unit certificates (that is, delivery of the original certificates and executed stock powers of attorney)*. This will give that lender priority over another lender who has, for example, only registered a PPSA financing statement in respect of such limited partnership units, whether such registration was made before, at the same time, or after the first lender obtained possession of the unit certificates.

On the other hand, a lender must continue to perfect its security interest over those limited partnership units that constitute "intangibles" governed by the Ontario PPSA by registering a financing statement. Delivery and control of the unit certificates and stock powers of attorney alone does not perfect a security interest over such limited partnership units.

An alternative to reviewing the limited partnership agreement to determine the status of its units is to take the belt and suspenders approach of registering a financing statement under the Ontario PPSA and obtaining delivery and control of the unit certificates and stock powers. This may also help to avoid any potential problems if in the future the limited partnership chose to amend its partnership agreement to either opt in, or opt out, of the STA.

*If the limited partnership units are uncertificated, or held in a securities account, a control agreement will need to be entered into by the lender with the issuer or the securities intermediary, as applicable.

Setting Aside a Borrower's Unauthorized Amalgamation
By: Richard Dusome

Credit Agreements usually contain a prohibition upon a borrower amalgamating with one or more other corporations without a lender's prior written consent. This is primarily because the amalgamation causes the liabilities of each amalgamating corporation to become the liabilities of the amalgamated entity. Of course, no lender wants its borrower's balance sheet to become tainted with debt to another creditor with uncertain priority.

So what happens when a borrower amalgamates without its lender's consent? Amalgamations have often been treated as a rather permanent corporate action once the Articles of Amalgamation were accepted for filing by the Ministry. Fortunately, the Ontario Court of Appeal recently affirmed a lower court decision ordering that an amalgamation can be set aside, on a discretionary basis, under the Court's general equitable jurisdiction. In TCR Holding Corporation v. Ontario, an amalgamated corporation successfully applied for an order of rectification in connection with its amalgamation with various of its subsidiaries. The applicant had thought that it was amalgamating with subsidiaries that had no liabilities, but later discovered that one subsidiary still had a significant liability under a guarantee which the amalgamated entity inadvertently inherited. In setting aside the amalgamation, the Court relied in part upon the fact that the amalgamating companies had agreed to the amalgamation based upon the mistake that the applicable subsidiary was debt free.

Although the TCR Holding case did not involve an application by a lender, it is nevertheless good news for any lender faced with an unauthorized amalgamation involving its borrower. The Articles of Amalgamation require an officer or director of each amalgamating corporation to certify that no creditor would be prejudiced by the amalgamation. If any borrower should recklessly or fraudulently deliver such a certificate in the face of liabilities of the other amalgamating corporations, the TCR Holding case suggests that a remedy is available other than just suing for damages that would be difficult to quantify. The Court can unwind the amalgamation to insulate a lender from the complications of its borrower inheriting unauthorized new found debt. The key is to act quickly before the amalgamated entity has the opportunity to enter into transactions with other innocent parties.

A Banker Asked Us:

In each issue we will highlight a specific question previously raised with us by one of our clients and our response.

Q: We are lending to a small private corporation which had four shareholders, all resident in Ontario. The shareholders of our borrower did not have a shareholders agreement regulating their respective rights upon the death or incapacity of any shareholder. Recently, one of the shareholders died suddenly leaving a married spouse and two young children, but he did not have a Will. What will happen to the shares of our borrower owned by the deceased shareholder at the time of his death? Could this negatively impact upon our borrower?

A: Since there is no Will, there is no named executor for the Estate. Someone will therefore have to apply to the court to be appointed as the administrator of the Estate. This will probably be the spouse of the deceased shareholder, but it could be another family member or friend if the spouse is not sophisticated or does not want the burden. The shares will continue to be held by and voted by the administrator until the administrator is able to sell the shares to one of the other shareholders or to a third party. However, the administrator is not obligated to sell the shares if he or she finds it would not be prudent to do so (for example if the available price was too low). In that situation, the administrator could choose to transfer the shares to the spouse or to the children in partial satisfaction of their rights under Ontario's intestate succession laws. This could be problematic if the transferee of the shares has no genuine interest or involvement in the business of your borrower.

Hopefully, one or more of the other three shareholders will want to step up to the plate and make an offer to purchase the shares of the deceased shareholder for fair value. This will remove the uncertainties associated with the administrator transferring the shares to a third party or to the spouse/children outright.

As part of your next annual renewal for this borrower, you will probably want to introduce a requirement that the remaining shareholders enter into a satisfactory shareholders agreement that covers death/incapacity issues so that there is a succession plan in place for the future to ensure an orderly transfer of shares.

Spotlight On Security Documents:

In each issue, we will discuss some of the practical applications of specific documents in your loan and security package:

The Inter-Company Subordination Agreement
By: Richard Dusome

When you have a large number of corporations and other entities within a borrower group, it can sometimes be difficult to keep track of the inter-company loans and any inter-company security held for each loan to determine what needs to be subordinated to the senior lender's debt and security package.

Instead of having each member of the borrower group provide a separate subordination agreement geared to the inter-company loans it has extended, you could have all members of the borrower group deliver a single Inter-Company Subordination Agreement. The document works to subordinate any present or future loans which any member might make to any other member to the debt owed to the senior lender. It also acts to subordinate any present or future security held by any member for those loans to the security held by the senior lender. Any new subsidiaries that later join the borrower group can sign a one-page joinder agreement at that time and will become subject to the Inter-Company Subordination Agreement.

This document has built-in flexibility in its terms to protect a senior lender from changes in the inter-company loan and security framework. Your borrower will be happy because multiple security documents have been merged into one resulting in some legal cost savings.

So in drafting up your future proposals and term sheets, you may want to consider including the Inter-Company Subordination Agreement as part of your security package. We would be happy to assist you with this document.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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