While the availability and securitization of credit is a cornerstone of the Canadian economy, there has nevertheless remained an intolerable degree of legal uncertainty surrounding the priority rules that should govern when Canadian federal and provincial security regimes collide. Neither provincial/territorial personal property security statutes ("PPSA") nor the federal Bank Act1 (the "Bank Act") address which secured party has priority when a borrower grants security over an asset to a bank under the Bank Act and another secured party under the PPSA. This uncertainty is most problematic when the party that has taken security under the PPSA has not registered or perfected its security thereunder.
In two decisions rendered by the Supreme Court of Canada concurrently on November 5, 2010, the Supreme Court finally resolved this issue, concluding that, as between Bank Act security and a previous unregistered, or unperfected PPSA security interest, the latter has priority. Although the PPSA requires a security interest to be perfected or registered to have priority over another security interest, the Supreme Court of Canada held that these elements only come into play when determining priority between PPSA security holders and not when determining priority between Bank Act security interests and PPSA security interests. In essence, the Supreme Court ruled that registration or perfection is a different concept than the security interest that is created under the PPSA, and that the order in which the creditors obtained a security interest, whether or not that interest is registered, is the determining factor in deciding a priority dispute between a creditor secured under the Bank Act and a creditor secured under the PPSA.
In Bank of Montreal v. Innovation Credit Union ("Innovation"),2 at issue was a priority dispute between a prior unregistered security interest taken under the Saskatchewan PPSA in farming equipment owned by the debtor and a subsequent security interest in the same collateral taken and registered by the Bank of Montreal under the Bank Act. The farmer did not disclose the loans granted by the Credit Union or its security interest to the Bank and the Bank's searches of the PPSA and the Bank Act security registries disclosed no prior security interests. After the debtor defaulted in its obligations to the Bank, the Bank seized and sold some of the property covered by its security. The Credit Union brought an application under the PPSA seeking a declaration that it had a priority claim over the proceeds of disposition.
In its companion case, Royal Bank of Canada v. Radius Credit Union Ltd. ("Radius"), 3the issue was again a priority dispute between a prior unregistered general security agreement in favour of the Credit Union and a subsequent security interest taken by Royal Bank of Canada and registered under the Bank Act in the same property. In this case, however, the dispute was specifically with regard to property that was acquired after the execution of both security agreements, which property was specifically contemplated by both agreements.
The Decisions of the Applications Judge
The applications judge concluded, in each case, that the priority rule specified by s.428 of the Bank Act, which gives a Bank Act security interest priority over subsequently acquired rights in respect of the property, also gives a bank priority over subsequently acquired priority rights. The applications judge applied this interpretation of s.428 of the Bank Act to conclude that, in each case, the Bank's interest, although acquired after the PPSA security was given to the Credit Union, took priority on the grounds that the PPSA security interest was not registered or perfected until after the registration of the Bank Act security.
The Decision of the Ontario Court of Appeal
Bank of Montreal v. Innovation Credit Union
In Innovation, the Saskatchewan Court of Appeal allowed the appeal of the Bank of Montreal ("BMO"), finding that the trial judge's reading of s.428 (as outlined above) could not be supported. The Court held that a proper reading of ss.427(2) and 435(2) of the Bank Act led to the conclusion that a bank cannot acquire a greater interest in the secured property than the debtor himself had at the time the Bank Act security was taken. Since the nature of Bank Act security is based on the title to the collateral in question, BMO took its security subject to the credit union's prior interest in the collateral, regardless of the fact that the latter was unperfected. In essence, the farmer could not give to BMO what he himself no longer had. This is known as the nemo dat quam non habet rule.
Royal Bank of Canada v. Radius Credit Union Ltd.
The same Court of Appeal also allowed the appeal of the Royal Bank of Canada ("RBC"), notwithstanding that it determined that a different analysis was required from that applied in Innovation.
Since the Radius case was a dispute over after-acquired property, the Court found that it was necessary to first determine the time at which each creditor acquired its respective security interest. After finding that the security interests attached simultaneously when the debtor purchased the collateral in question, the Court of Appeal held that the common law principle of "first in time is first in right" applied. Therefore, notwithstanding the Credit Union's failure to perfect its security interest under the PPSA, the first-in-time rule applied to the date of execution of the respective security agreements. Since the Credit Union was first to acquire a security interest in the after-acquired property, the Court found that it had priority.
In each case, the bank in question appealed to the Supreme Court of Canada.
The Decision of the Supreme Court of Canada
The Supreme Court of Canada unanimously rejected the banks' appeals and, in both cases, ruled in favour of the credit unions. The following is a synopsis of its reasoning.
Bank Act and the PPSA
The Supreme Court of Canada began its reasoning in Innovation by discussing some preliminary matters. First, Justice Charron outlined the differences between the federal and the provincial security statutes, the former being a property-based security regime and the latter being a priority-based regime no longer concerned with the issue of title to the collateral it is meant to secure. Justice Charron explained that the Bank Act expressly gives a Bank Act security interest priority over "all rights subsequently acquired in, on or in respect of" collateral property, but is silent with respect to conflicting third party interests acquired prior to the attachment of the Bank's security in the collateral.4 Furthermore, since the Bank Act is a valid federal statute, the Court explained that provinces cannot enact provisions that would affect the priority of a validly created federal security interest. Justice Charron concluded that the conceptual framework for resolving disputes between PPSA security interests and Bank Act security interests must therefore be that which is supplied by the Bank Act itself by way of ss.427(2) and 435(2).5 As for the priority rules outlined in the PPSA, the Supreme Court confirmed that they were of no assistance in the matter:
...the time of perfection or the lack of perfection does not determine the nature or validity of the interest. Rather, the concept of perfection plays a role in determining which of two or more competing security interests takes priority under the PPSA ... this dispute must be resolved by examining what rights were acquired by the Bank when it took its security interest and determining whether those rights were subject to the Credit Union's prior PPSA interest.6
The Nature of the Competing Security Interests
After making it clear that the source for resolving priority disputes between Bank Act security and provincial interests, such as PPSA security, is the Bank Act itself, the Supreme Court set out to ascertain the type of security acquired under each security regime. With respect to the Bank Act, the Court confirmed that it is a property-based regime and concluded that, "the combined effect of ss.427(2) and 435(2) is that the bank can acquire no greater interest in the collateral than the debtor has at the relevant time".7 Bank Act security effectively conveys to a bank legal title to whatever rights the debtor holds in the assigned property. As a result, when BMO acquired Bank Act security, it effectively acquired legal title to the properties in each respective case.
The PPSA, on the other hand, is not a property-based regime, but rather a contemporary priority-based regime that involves a series of rules that establish priority rankings, both as between different security interests and as between security interest and other interests in the property.
BMO argued that, since a PPSA secured creditor does not acquire the debtor's right and title to the collateral, the debtor's interest as owner of the collateral is not lost in granting a PPSA security interest. In essence, BMO argued that, even though PPSA security had been taken, the debtor was still free to convey its full interest in the collateral to BMO under s.427 of the Bank Act. In addition, BMO argued that, while title was free to be conveyed, the prior grant admittedly affected the Bank Act security given and thus the Court ought to apply the first-in-time-to-register principle. Finally, BMO pointed out that allowing an unregistered and effectively undiscoverable prior PPSA security interest to take priority over a Bank Act security interest would lead to commercially absurd results since banks are not able to discover unregistered security interests which may have been previously granted by their customers.
Resolving the Priority Dispute
While the Supreme Court recognized the merits behind BMO's arguments, it ultimately did not agree. It pointed out that characterizing PPSA security as a type of floating charge that does not encumber legal title had already been rejected by the Supreme Court in Royal Bank of Canada v. Sparrow Electric Corp.8, wherein it was confirmed that PPSA legislation treats all charges, including floating securities, as fixed charges and that security interests taken under the PPSA are "correlative to the notion of a creditor's having legal proprietary rights in the collateral, a right which represents a proprietary interest over a dynamic collective of present and future assets."9 This means that, at the time BMO took its security interest, Innovation held a valid security interest in the nature of a fixed charge, notwithstanding the lack of perfection, because registration determines neither the nature nor the validity of a security interest. While the PPSA does not contain any provisions that specify the nature of a PPSA security interest in proprietary terms, the effect of the legislation is to create a statutory interest which is analogous to an inchoate (or unrealized) property right applicable to both present and after-acquired property.
The Supreme Court further concluded that BMO's objection to unregistered PPSA security interests taking priority over registered Bank Act security interests is an objection that should be directed toward Parliament and not the judiciary:
Of course, it would be open to Parliament to amend the Bank Act and to add expressly a priority rule which would subordinate a prior unperfected PPSA interest to a subsequent Bank Act interest. However, such a rule can only be judicially created if it is not contrary to the provisions of the Bank Act in its existing manifestation. In my view, the adoption of a first-to-register rule would run contrary to ss.427(2) and s.435(2). The failure to register does not take anything away from the nature and validity of the Credit Union's prior interest ... The effect of s.427(2) is that a bank takes the debtor's property subject to any pre-existing interest held by a third party. This means that a prior PPSA security interest will have priority over a subsequent Bank Act security. This holds true even if the prior PPSA security interest was not perfected. There is nothing in the Bank Act that subordinates a prior PPSA security interest for lack of perfection. Thus, the Court cannot override the provisions of the Bank Act.10
The Supreme Court came to the same conclusion in Radius, notwithstanding the fact that the collateral property in question was after-acquired property. The Court made it clear that while "the statutory interest created in after-acquired property is necessarily inchoate in nature until the debtor acquires rights in the property, that does not change the fact that, as of the date of execution, the creditor (Credit Union) ... acquired an interest in the after-acquired property which derogated from the debtor's title."11
It is now settled law that Bank Act security conveys no more than a debtor's legal interest in the assigned property at the time Bank Act security is taken to a bank and where prior PPSA security interests exist, they will take priority over Bank Act security. It is further settled that this result will prevail even where such PPSA security interests are unregistered or unperfected and, hence, not discoverable. As a result, the Supreme Court of Canada's decisions in Innovation and Radius have recently been dubbed 'a blow to chartered banks' that could potentially spur federal Bank Act reform.12 In the meantime, they certainly serve to undermine the purpose and effectiveness of the statute. While it still does not hurt for banks to take Bank Act security over the property of their borrowers, banks should ensure that their security interests are also registered under the applicable PPSA.
1Bank Act, S.C. 1991, c. 46
2.Bank of Montreal v. Innovation Credit Union., 2010 SCC 47
3.Royal Bank of Canada v. Radius Credit Union Lt., 2010 SCC 28
4.Bank of Montreal v. Innovation Credit Union, 2010 SCC 47, at para. 16 (SCC).
5.Ibid., at paras. 27-29.
6.Ibid., at para. 34.
7.Ibid., at para. 29.
8.Royal Bank of Canada v. Sparrow Electric Corp.,  1 S.C.R. 411
9.Supra note 4, at para. 47.
10.Ibid., at para. 53.
11.Supra note 3, at para. 31
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