Rarely do judicial decisions arising under bulk sales legislation garner much attention. That being said, there really aren't many to be found, given the fact that the legislation isn't exactly novel and has been viewed as so ineffective or irrelevant that it has been repealed pretty much everywhere but Ontario.
Every so often, however, a decision comes along that piques everyone's interest. As we discussed in a blog post last week, the Ontario Superior Court of Justice recently found the Bulk Sales Act(BSA) to be inapplicable to a proposed lease and equipment securitization transaction. The decision, Cle Leasing Enterprises Ltd. (Re), has certainly caught the attention of commercial lawyers and, more specifically, lawyers in the securitization bar.
Hopefully, the decision will resolve the issue of the legislation's applicability to securitization transactions or, better yet, give rise to a renewed effort to convince the government to finally repeal the legislation.
The Bulk Sales Act
But first, some background. By its terms, Ontario's BSA applies to a "sale in bulk", which is a sale of "stock in bulk" out of the usual course of business or trade of the seller. "Stock" is defined as goods, wares, merchandise or chattels ordinarily the subject of trade and commerce, in which a person trades or that the person produces or that are the output of a business or with which a person carries on a trade or business. Some sales in bulk are specifically exempted – for example, bulk sales by an executor, an administrator, a guardian of property, a creditor realizing on security, a receiver or trustee for the benefit of creditors or a bankruptcy trustee are all exempt from the application of the BSA. If the buyer fails to comply with the BSA, a sale in bulk is voidable and the buyer is then personally liable to account to the creditors of the seller for the value of the stock in bulk.
Although the BSA doesn't apply to sales of receivables/intangibles, it potentially applies in the context of a lease securitization transaction where an interest in leased equipment is sold to a special purpose entity as part of a transaction that is structured to be bankruptcy-remote to the seller. Fundamentally, whether the BSA applies to this type of securitization transaction comes down to whether or not a sale undertaken in connection with a securitization transaction is in the seller's "usual course of business or trade" and until now there has been no judicial authority considering this issue.
Given the potential downside of failing to comply with the BSA (that is, the voiding of the transaction) and the fact that compliance would be onerous (if not impossible as a practical matter), it has become common practice to require an asset seller to obtain an exemption under the BSA as a condition of closing. A judge can exempt a sale in bulk from the application of the BSA if the judge is satisfied that the sale is advantageous to the seller and will not impair the seller's ability to pay creditors in full. These requirements are not difficult to satisfy in the context of a securitization transaction. Sometimes in a program structured to permit periodic (and often frequent) sales of assets, this order is obtained with respect to all sales that will be made from time to time under the program (which is possible since the sales are conducted under a master agreement on effectively the same commercial terms). Obtaining a blanket order provides cost savings for the asset originator as it eliminates the need to go to court every time it wishes to sell assets.
The Applicant's Initial Sale
On February 27, the Court released the first of two decisions. The case involved an asset originator that applied for a BSA exemption order in the context of a lease securitization transaction that would extend to the initial sale, as well as future sales under a program. The company's lawyers took the position that the initial sale under the program was subject to the BSA as it was a "sale in bulk", but that future sales would not be considered bulk sales.
Justice Brown found this approach to be inconsistent, stating that the BSA either applied or didn't apply to all sales under the program. Accordingly, Justice Brown granted an order for the initial sale on the basis that the transaction was advantageous to the seller (permitting it to access new financing) and wouldn't impair ability to pay creditors, but questioned why the court should have to expend its scarce judicial resources considering BSA exemption orders for these types of financings (or other "securitization variants thereon") that have become "popular in recent years".
In rendering his decision, Justice Brown referred to the 2003 Supreme Court of Canada case of National Trust Co. v. H&R Block Canada Inc., in which the court stated that the BSA applied to any sale of goods "out of the usual course of business or trade of the seller", which means that any sale of all or substantially all of the assets of a business or a sale of the assets used to operate a business must comply with the BSA. The Court also cited the 2003 decision of the Ontario General Division in Millgate Financial v. BCED Holdings, in which the Court observed that the usual course of business might extend to activities and reorganizations undertaken for the purpose of obtaining financing.
Justice Brown went on to state that if, notwithstanding the clear language of the Supreme Court of Canada in the National Trust case, the commercial bar lacked the confidence to rely on the principle that the BSA did not apply to these types of financings, then something had to be done. In Justice Brown's view, seeking such exemptions as a result of unclear language in a very old statute undermined the "efficient workings of our economy" (which isn't normally thought to be within the purview of the courts).
Thus, while the Court ultimately granted the exemption, it also directed the applicants to bring any future applications on notice to the Attorney General of Ontario so as to allow for a determination of whether this type of financing "sale" falls within the ambit of the BSA.
In accordance with Justice Brown's initial order, the applicant's subsequent application for a BSA exemption was made on notice to the Attorney General.
As we discussed in our earlier post, the Court ultimately found that the proposed transaction did not fall within the BSA's definition of "sale in bulk". To fall within the definition, such sales must be outside the usual course of business or trade of the seller. The Court, however, distinguished the proposed transaction from those captured by the BSA, characterizing the transaction in this case as a sale "for the purpose of raising financing in the ordinary course of the operations of the applicants' business." The Court further questioned why the BSA would apply to the proposed transaction when it did not apply to an alternate method of financing, that of simply borrowing money from a financial institution and charging the leases and equipment as security for the loan.
The Court chose to base its decision on the dicta in Millgate Financial rather than that of National Trust:
Although it would be open to me to conclude that the Proposed Transaction was not a sale made out of the ordinary course of business because it involved only 7.5% of the total assets of the applicants – hardly the "all or substantially all" described in the National Trust case – I think it makes more commercial sense to rest my conclusion that the sale is not one made out of the ordinary course on the basis that the purpose and design of the Proposed Transaction is to secure ordinary course financing for the applicants. (at para. 22)
Thus, the Court ultimately found that the BSA "was not intended to regulate, nor by its terms does it result in the regulation of, an ordinary course financing technique such as the type of asset securitization involved in the Proposed Transaction." In other words, the Court found that, notwithstanding the form of the transaction which utilized the technique of legal sale, it should be considered to be merely an alternate form of financing, falling within the applicant's usual course of business or trade and thus outside the scope of the BSA.
Thoughts Going Forward
There are no compelling policy reasons for the continued existence of the BSA. This case is but one illustration of how the BSA can cause delay and increased costs for businesses. Unfortunately, somewhat of an onerous burden was placed on the asset originator in this case. However, perhaps the upside to this decision is the renewed hope that there may be some clarity shed by the legislature on this matter in the not too distant future.
Until then, however, the securitization bar must come to grips with how it will deal with the BSA. Hopefully, the strength and clarity of this decision will give the bar the comfort necessary to allow it to give and accept unqualified financing level opinions without the necessity of obtaining BSA orders.
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.