Canada: Fully Secured @ Gowlings, December 14, 2011 - Volume 2, Number 4

Edited by Richard Dusome

British Columbia: PPSA Amendments Will Add Clarity to Licences as Collateral

The definition of the term "licence" in the British Columbia Personal Property Security Act ("BCPPSA") will be changing, making it easier for holders of licences relating to personal property to use them as collateral to obtain credit.

Currently, and unique to BC, the BCPPSA defines a "licence" as a right under an agreement referred to in section 12 of the Forest Act (BC). In addition to this restrictive definition, there is a line of cases in Canada which makes it unclear whether certain licences, permits and quotas, particularly those issued by a governmental authority, are personal property which can be subject to a security interest granted under personal property security legislation.

To overcome these limitations, the proposed change to the BCPPSA greatly expands the definition of "licence" to mean a grant of rights which entitle the holder of the right to deal with or acquire personal property or provide services. The definition would include licences granted by a governmental authority, such as fishing, forestry and liquor licences, and non-governmental licences relating to personal property entered into between other parties. Licences are also included in the definition of "intangibles", and are therefore personal property to which the BCPPSA applies.

This expanded definition will make it easier for licence holders to borrow on the security of their licences and for creditors to take enforceable security against that property.

The amendments to the BCPPSA were introduced in the BC legislature on October 3, 2011 and are expected to come into force some time in 2012.  We will let you know in a future edition of Fully Secured when the changes become effective.



Ontario: How to Package Your Subordination Arrangements in Time for the Holidays ... or any Other Time of the Year

The importance of tieing up any and all loose ends on subordination arrangements was highlighted in an Ontario Court of Appeal decision regarding a priorities dispute between two secured creditors of an insolvent corporation1.

It all started in 2004 when three secured parties, Bank of Nova Scotia ("BNS"), the VenGrowth group ("VenGrowth") and Kari Holdings Inc. ("Kari"), entered into an inter-creditor agreement regarding their respective interests in C.I.F. Furniture Limited ("CIF") which provided that the distribution of any proceeds of disposition would be made in accordance with the following priority rankings: (1) first to BNS to the extent of its loans to CIF; (2) second to VenGrowth to the extent of its subordinated debenture in the amount of $4.35 million; (3) third to Kari to the extent of its $1 million secured note; and (4) fourth to VenGrowth to the extent of the additional loans it had advanced to CIF over and above the debenture.  BNS was paid out in 2006.

In 2008 there was a turn of events which brought Comerica Bank ("Comerica") in as a secured operating lender to CIF.  For this financing Comerica contracted with each of VenGrowth and Kari separately.  VenGrowth agreed to be a guarantor and to subordinate its security interest to Comerica's security interest under the terms of an inter-creditor agreement.  Meanwhile, Comerica agreed, under the terms of its credit agreement with CIF, to give Kari a "first priority lien" while it took a "second priority lien".  But you will recall that under the 2004 arrangements Kari came behind VenGrowth to the extent of the $4.35 million debenture.

Unfortunately for the creditors involved, there was no inter-creditor agreement to which all three secured creditors were parties to sort out this type of priority conundrum.

The interaction of the 2004 and 2008 financing arrangements established the following relative priorities of the creditors:

  • VenGrowth ranked ahead of Kari under the 2004 inter-creditor agreement
  • Kari ranked ahead of Comerica under the 2008 credit agreement
  • Comerica ranked ahead of VenGrowth under the 2008 inter-creditor agreement

Are you starting to see circles?  Under the circumstances, there was no question that Comerica ranked first but what position did each of VenGrowth and Kari hold under the two financing arrangements? VenGrowth and Kari took their dispute to Court where the Ontario Superior Court of Justice applied a theory of partial subordination and found in favour of VenGrowth.  This decision was upheld at the Ontario Court of Appeal. 

Kari argued a theory of complete subordination should be applied by the Court.  A complete subordination would require VenGrowth to give up its priority to Comerica and also to Kari because Kari had been granted a "first priority lien" under the 2008 Comerica credit agreement.  The following priority rankings would result from that application: (1) first to Kari; (2) second to Comerica; and (3) third to VenGrowth. 

VenGrowth argued for the application of a theory of  partial subordination which would require VenGrowth to only give the benefit of its first priority under the 2004 inter-creditor agreement to Comerica up to a maximum amount of $4.35 million (its debenture).  The application of a partial subordination would result in the following priority rankings: (1) Comerica would have first priority to a maximum of $4.35 million, with VenGrowth retaining first priority only for a maximum amount equal to $4.35 million less the amount of Comerica's claim; (2) second priority to Kari; (3) third priority to Comerica for any claim in excess of $4.35 million; and (4) fourth priority to VenGrowth for all of its remaining claims.

Both Courts rejected the application of a complete subordination in favour of a partial subordination because the latter application produced an equitable result.2  A complete subordination would have allowed Kari to rank ahead of VenGrowth as a result of the 2008 financing and confer a windfall on Kari (i.e. Kari was never meant to rank ahead of VenGrowth).  As additional support for its decision, the Court of Appeal noted that there was no document whereby VenGrowth explicitly agreed to completely subordinate its interest to Kari's interest.

The lesson to be learned from this case is not the outcome itself but the fact that the time and resources used to litigate this dispute could have been avoided if the parties  had addressed their relative priorities in a single inter-creditor agreement in 2008 that tied up all the loose ends and made sure all the parties were on the same page. 

Moral of the story: do your due diligence, stay on top of things and make sure you always get in writing the intention of all secured parties necessary to protect your priority interests. The case also demonstrates the importance for lenders to ensure that any statement set out in a term sheet of their intention to subordinate to another creditor (X) does not extend to an intention to subordinate to other creditors to whom X may have agreed to subordinate.

Footnotes

1. C.I.F. Furniture Limited (Re), 2011 ONCA 34.

2. It may have been an entirely different situation had Comerica's debt been greater than $4.35 million.



Quebec: What Secured Lenders Need to Know About the Draft Bill to Enact the New Code of Civil Procedure

The Draft Bill to Enact the New Code of Civil Procedure was introduced by the Quebec Minister of Justice on September 29th, 2011.  This Draft Bill, the main goals of which are to promote access to justice, reduce costs, promote collaboration between parties and simplify and improve the quality and efficiency of the judicial process, is a new proposed code that would replace the current Civil Code of Procedure.

The new code, if adopted, will have a substantial impact on the mortgage enforcement process. Lenders will have to support a higher financial burden, new significant delays and a loss of control over judicial sales. Here are some of the most significant proposed changes that all secured lenders need to know about. 

New person  designated to proceed with sales under judicial   authority 

Sales under judicial authority will now be conducted exclusively by bailiffs, who may seek the assistance of a lawyer who is not related to any of the parties (art. 741).

The bailiff will have the choice to proceed by mutual agreement, by call for tenders or by auction.  The bailiff will fix the conditions for the sale, under reserve of those fixed by judgment ordering the surrender of property within the context of a hypothecary action (art. 742).

Read the full article - Quebec: What Secured Lenders Need to Know About the Draft Bill to Enact the New Code of Civil Procedure



Will the New Supreme Court of Canada Appointments Change Banking Law?

On November 14, 2011, Andromache Karakatsanis and Michael Moldaver were sworn in as the two newest members of the Supreme Court of Canada to fill the vacancies created by the retirement of Justices Ian Binnie and Louise Charron. 

The retirement of Justice Binnie is significant to banking law because Justice Binnie sided with the majority in the 4-3 decision in Canada Trustco Mortgage Co v Canada, [2011] SCJ No 36, which was released on July 15, 2011.  Canada Trustco was the Supreme Court of Canada's most recent consideration of banking and finance law and is noteworthy for the strong dissent of Chief Justice McLaughlin, whose reasoning would have had serious ramifications to banking law had it been in the majority.

Canada Trustco Mortgage Co v Canada, [2011] SCJ No 36

In Canada Trustco, a lawyer, McLeod, was a tax debtor as defined by the Income Tax Act, RSC 1985, c 1.  Canada Revenue Agency ("CRA") learned that cheques payable to McLeod were being drawn on McLeod's trust account and being deposited to the credit of a joint account in which McLeod was an accountholder.  Each cheque bore an endorsement identifying the joint account as the specific account to which the funds were to be credited.

Both McLeod's trust account and the joint account were maintained by Canada Trustco Mortgage Company ("Trustco").  CRA issued three requirements to pay to Trustco under section 224 of the Income Tax Act, to intercept funds "payable" from the trust account to the joint account.1  When Trustco did not pay the funds to CRA, CRA sued Trustco.

Read the full article - Will the New Supreme Court of Canada Appointments Change Banking Law?



Nova Scotia: Court Confirms High Burden of Proof on a PMSI Creditor to Pull its Assets out of an en bloc Sale

A recent decision of the Nova Scotia Supreme Court has confirmed that a PMSI creditor cannot trump what is in the best interests of the general body of creditors in order to avoid potential prejudice to itself.  In the Companies' Creditors Arrangement Act proceedings concerning Scanwood Canada Limited ("Scanwood")1, the Court refused to grant the request of the PMSI creditor, Homag Canada Inc. ("Homag"), to lift the stay ordered in a receivership order against the assets financed by Homag.  Lifting the stay would have effectively removed Homag from an en bloc sale process and permitted it to seize the assets over which it held a PMSI in order to sell them on its own.

Homag held a PMSI secured debt of $611,000. The company brought a motion seeking an Order that Homag held a first ranking security interest in certain assets of Scanwood that it had financed, and granting it leave to exercise its enforcement rights against Scanwood.  The purpose of Homag's motion was to remove its assets from the en bloc sales process already approved by the creditors and supported by the receiver.  The motion was opposed by the receiver, the DIP lender, and the remaining creditors as the Homag assets represented an integral part of Scanwood's production capacity.  Homag argued that it could generate a greater return on its security by selling its assets through its own sale process rather than participating in an en bloc sale process.  While Homag conceded that the other secured creditors might benefit from the en bloc sale, Homag argued that it would suffer prejudice because its equipment would generate a lower bid in an en bloc sales process than if Homag sold the assets on its own.  Particularly, Homag did not wish to contribute to the costs of the receivership and other priority costs pursuant to the court order approving the DIP financing.  In support of its motion, Homag's president filed an affidavit which included his opinion that the maximization of the equipment would be best achieved by not participating in the en bloc sale.  No evidence was presented to support the president's opinion, such as potential offers, offers received, or efforts made by Homag to market its assets.

The receiver argued that the purpose of the stay was to prevent a "free for all" by the secured creditors and, instead, to provide for an orderly realization of Scanwood's assets for the benefit of all creditors.  The receiver's report advised that certain parties had already expressed their interest in submitting tenders, and that the absence of Homag's equipment as part of the sale process would seriously impact the receiver's ability to attract an en bloc buyer.  The receiver and DIP lender argued that if the lift was granted, Homag's interests would be placed ahead of those of the DIP lender and would unfairly relieve Homag from the burden associated with the priority given to the administration and director's charges set out in the DIP financing Order.

The Court held that Homag did not meet its burden to show that it would suffer objective material prejudice if the stay was not granted, and that the affidavit evidence of its president was insufficient proof that Homag would be materially prejudiced.  The Court concluded that the benefits of an en bloc sale to the general body of creditors outweighed any potential prejudice to Homag.

This case confirms that PMSI creditors seeking a lift of the stay will have to provide convincing evidence to meet the high burden of proof of objective material prejudice.  A "bald assertion of prejudice" based on opinion is insufficient.  Although the court is not bound by the decision of the majority of creditors, in exercising its discretion to lift stay, the Court must have, above all else, regard to what is in the best interests of the general body of creditors.  That interest must then be weighed against the disadvantages that the creditor seeking the lift would suffer if leave was not granted.  The burden of proof to show material prejudice will always be on the party seeking the leave and it must present credible evidence in that regard. This case should provide some comfort to DIP lenders and other secured creditors that PMSI creditors cannot easily remove themselves from an en bloc sales process.

Footnote

1. 2011 CarswellNS 564, 2011 NSSC 189.



  A Banker Asked Us: Motor Vehicles and Vehicle Identification Numbers

Q:        The bank is planning to take security in Ontario over a new borrower's motor vehicles in addition to all of its other assets.  Do I need to register against all the vehicle identification numbers of those vehicles?

A:        If a motor vehicle constitutes "consumer goods" in the hands of a borrower, the Ontario PPSA requires that the financing statement registered against the borrower to perfect the security interest in that motor vehicle also include a check in the "Motor Vehicle" collateral classification box as well as the relevant Vehicle Identification Number ("VIN")*.  In all other situations, the Minister's Order under the PPSA provides the secured party with the discretion to include the VIN on the applicable financing statement.  However, including each and every applicable VIN in its registration will give the secured party greater protection against the competing interests of some third parties seeking to purchase the motor vehicle from the borrower.

The provisions of the Ontario PPSA relating to motor vehicles create distinctions based upon whether the motor vehicles constitute "consumer goods" (generally defined as goods used or acquired for use primarily for personal, family or household purposes), "equipment" (like tow trucks for a towing business) or "inventory" (like cars in a car dealership) in the hands of the borrower.**  They also depend in some cases upon whether a secured asset is sold within the ordinary course of business or outside the ordinary course of business.

If the motor vehicle constitutes consumer goods of the borrower, then the VIN must be recorded to perfect the security interest as described above.

If the motor vehicle constitutes goods (i.e. either inventory or equipment) and it is sold in the ordinary course of business, Section 28(1) of the PPSA provides that the buyer takes the motor vehicle free from any security interest therein given by the seller which is known to the buyer, unless the buyer also knew the sale constituted a breach of the applicable security agreement.  Registering against the VIN will not assist the secured party in the case of ordinary course sales.   

However, where the motor vehicle is classified as equipment of the seller and it is sold outside of the ordinary course of business of the seller, Section 28(5) of the PPSA provides that the buyer will take the motor vehicle free of any security interest given by the seller unless the VIN is included in the financing statement, or unless the buyer knew the sale constituted a breach of the applicable security agreement.  Given the difficulties presented to a secured party in trying to prove such knowledge on the part of the buyer, including the VIN in its registration is a much simpler way for the secured party to acquire protection against these buyers.

Despite the benefits associated with including the VINs in the registrations, the administrative efforts associated with completing, monitoring and maintaining those registrations and discharge requests may be significant.  Dealing in the 17 digit combinations of letters and numbers comprising the VINs can yield frequent administrative errors.  Indeed, some car dealership borrowers may specifically request that lenders forego all VIN registrations to avoid impediments to completing sales promptly.

*  The Minister's Order requires that information about the vehicle make, model and model year must be included in addition to the VIN.

**  There are similar provisions for leased vehicles and special requirements under Section 25(5) for motor vehicles which constitute proceeds of other secured assets.

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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