The issue of whether an unsecured party can purchase a secured
party's debt to shelter its own unsecured debt under the newly
acquired security is often debated. To date, there has been little
Canadian jurisprudence addressing this practice. The recent case of
CPC Networks Corp. v. Eagle Eye Investments
Inc.1 confirms that the practice does not work.
Security agreements often contain "all obligations"
clauses which secure all of a debtor's present and future
obligations owed to a secured creditor. Occasionally, all
obligations clauses have been used in an attempt to convert
unsecured debt to secured debt by either (a) assigning the security
agreement to an unsecured creditor or (b) assigning unsecured
claims to a secured creditor. These situations have been considered
by courts in England, Australia, New Zealand and the United States,
but Canadian case law on this issue has been very limited.
In Eagle Eye, an unsecured creditor obtained an
assignment of a secured creditor's debt and related security.
The unsecured creditor then claimed that its pre-existing unsecured
debt was transformed into secured debt as a result of the all
obligations clause contained in the assigned security.
The unsecured creditor took the position that since the assigned
security covered all present and after-acquired liabilities of the
debtor to the original creditor, and since the unsecured creditor
had stepped into the shoes of the original creditor by virtue of
the assignment of the debt and related security, all debts owed by
the debtor to the unsecured creditor, including the prior unsecured
loan, were secured by the assigned security.
The debtor argued that the actions of the unsecured creditor
were contrary to section 65 of the Personal Property Security
Act (Saskatchewan) (the "PPSA") which requires that
parties to a security agreement act in good faith and in a
commercially reasonable manner. Furthermore, the debtor submitted
that the terms of the assigned security were subject to the terms
of the assigned debt documents which did not contemplate the prior
unsecured loan between the unsecured creditor and the debtor.
The court held in favour of the debtor, agreeing that the
assigned security did not extend to the prior unsecured loan
between the unsecured creditor and the debtor. Without providing an
indication of which reasons were primarily relied upon, the court
provided the following reasons for its decision:
the assignment of the debt and related security was not done in
good faith or a commercially reasonable manner;
the all obligations clause should be read literally so as to
limit it to indebtedness between the original parties;
it would be inequitable to allow an unsecured claim to jump the
priority queue by obtaining an assignment of a higher priority
a broad interpretation of the all obligations clause would be
unfair to the debtor since the debtor would not normally anticipate
that an all obligations clause would be used by an unsecured
creditor to transform itself into a secured creditor by obtaining
an assignment of a security agreement;
allowing an unsecured creditor to convert its unsecured claim
into a secured claim by obtaining an assignment of a security
agreement would have a destructive impact on the principle of pro
rata sharing in bankruptcy law; and
a broad interpretation of the all obligations clause would
compromise the predictability, reliability and integrity of the
PPSA priority structure.
While we are uncertain whether another court would accept all of
the reasons set out above in making a similar determination, this
case is instructive as to the concerns that may be raised.
The British Columbia Court of Appeal has recently considered whether the doctrine of unconscionability can be invoked to set aside a contractual clause providing for the payment by one party to the other...
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