On November 23, 2011, the federal government introduced Bill S-5 on the Senate floor as part of the five-yearly update and review process of legislation governing federally regulated financial institutions.1 The bill passed third reading in the Senate on December 16, 2011 and is awaiting first reading in the House. One of the most notable changes in this omnibus bill are the proposed amendments to sections 425-428 of the Bank Act, which will effectively override the Supreme Court of Canada's decisions in Bank of Montreal v. Innovation Credit Union and Royal Bank of Canada v. Radius Credit Union Ltd.2 relating to the priority of federal Bank Act security vis à vis provincial personal property security.3
Last year, in two companion decisions that took many in the banking community by surprise, the Supreme Court of Canada ruled that a prior but unperfected PPSA security interest has priority over a subsequent Bank Act security interest. In each of those cases, a debtor had executed a general security agreement in favour of a credit union providing security for all present and after-acquired property. Before either credit union had registered a Saskatchewan PPSA financing statement to perfect their respective interests, the debtor obtained further financing from a bank and provided Bank Act security over much of the same collateral. The dispute involved competing federal and provincial regimes with no rules of priority as between the two. The Court held that the later registered Bank Act security ranked behind the earlier but unregistered (and therefore unperfected) PPSA security even though no search would have disclosed the existence of the PPSA security: in the absence of any statutory priority rules, the common law rules of "first in time" and "nemo dat quod non habet" dictated that the registered Bank Act security must be subject to the earlier unregistered PPSA security. In so deciding, the Court noted that the "bank's argument that this interpretation leads to commercially absurd results echoes the numerous cries for legislative reform and is not without merit."
In Bill S-5 the cries for reform have been answered, although perhaps not as clearly as one might wish. Under the proposed amendments to sections 426(7) and 428(1), a Bank Act security interest has priority over the rights of "any person who had a security interest in that property that was unperfected at the time the bank acquired its security in the property". Further, section 425(1) will include a broad and general definition of "unperfected" as recognized by the law under which the security interest is created. Based on these changes, the Bank Act security amendments in Bill S-5 are clearly intended to override the Court's decisions in Innovation Credit Union and Radius Credit Union.
Regrettably, Bill S-5 does not go so far as to adopt a PPSA style "first-to-register" or "first-to-perfect" rule to resolve a conflict between Bank Act security and a PPSA security interest regardless of the parties' knowledge. Instead, under new s.426(7.1) and amended s.428(2) the priority of Bank Act security over an earlier unperfected PPSA security interest does not extend to situations where the bank acquired its security with knowledge of the PPSA secured party's unperfected security interest. Therefore, a prior unperfected security interest would still rank ahead of Bank Act security where the bank acquired that security with knowledge of the prior security interest. Knowledge is not a defined term and this ambiguity potentially leaves the door open for arguments based on constructive knowledge of the bank of a prior unperfected security interest. Given the size and national scope of Canada's major chartered banks, the knowledge exception may defeat the goal of greater certainty that could have been achieved through a more rigorous PPSA style regime. Would a borrower's casual comment to an account manager in a bank's Whitby branch about an existing unperfected security interest fix the bank's downtown Toronto branch with knowledge that would effectively subordinate any later Bank Act security that the borrower granted to the bank? Such questions may need to be resolved through litigation, but litigation is exactly what such legislative amendments should be designed to avoid.
The amendments are also silent on priority as between a prior perfected PPSA security interest and subsequent Bank Act security. Presumably, the common-law "first-in-time" priority rules would continue to apply as between these security interests. A personal property security interest that is registered or otherwise perfected before the Bank Act security attaches would have priority over the Bank Act security interest, and vice-versa.
The proposed Bank Act security amendments in Bill S-5 offer a few much needed patches to some of the legislative gaps exposed by Innovation and Radius. But they do not address the larger question of whether the rickety edifice of Bank Act security has finally outlived its usefulness and may not be worth preserving at all.
The coming into force date of Bill S-5 has not yet been determined.
1 Bill S-5, Financial System Review Act (An Act to Amend the Law Governing Financial Institutions and to Provide for Related and Consequential Matters), 1st Sess., 41st Parl., 2011.
2 Bank Act, S.C. 1991, c. 46; Bank of Montreal v. Innovation Credit Union, 2010 SCC 47; Royal Bank of Canada v. Radius Credit Union Ltd., 2010 SCC 48.
3 These cases were discussed in detail in the November 2010 McMillan Financial Services Bulletin. See Rob Scavone, Lisa Brost and Richard McCluskey, "Supreme Court weighs in on the battle of the security regimes" (November 2010).
The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.
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