In this issue:
- Court Disallows Sheltering of Unsecured Debt under Prior Ranking GSA
- Update on Bank Act Security Amendments
- British Columbia: The Dangers of Using the Prescribed Standard Mortgage Terms
- Security on Commercial Licences: Developments Since the Saulnier Case
- A Banker Asked Us: What is a "fondé de pouvoir" and Why do I need one in Québec Syndicated Loan Transactions?
- Security Granted Following Payment Default Held to be Improper Preference
- Spotlight on Security Documents: The Forbearance Agreement
Court Disallows Sheltering of Unsecured Debt under Prior Ranking GSA
By: Lisa MacDonnell (Toronto)
A Saskatchewan court has recently struck down an unsecured creditor's attempt to elevate its position by taking an assignment of the prior ranking debt of another creditor and the security related to that debt.
The claim arose out of a dispute between two adverse shareholder groups of the borrower ("CPCN"). One shareholder group ("EE") had made several advances of unsecured debt to CFCN over a period of time.
At issue in Eagle Eye1 was whether a general security agreement ("GSA") entered into by CPCN in favour of the Business Development Bank of Canada ("BDC") could be used to secure CPCN's previously unsecured debt owing to EE.
In 2008, CPCN entered into a loan agreement with BDC. As security for the loan agreement, CPCN entered into the GSA in favour of BDC. The GSA contained an "all obligations" clause which provided that the security interest granted was intended to secure the repayment of all present and future indebtedness of CPCN to BDC. In 2011 BDC assigned the debt and related security to EE.
When CPCN tried to pay-out the BDC debt and obtain a discharge of the BDC security, EE included the originally unsecured debt in the pay-out statement and claimed that it also had to be paid in order to discharge the security due to the "all obligations" clause in the GSA.
CPCN then brought an action for the court to determine the amount of the debt required to be paid in order to obtain a discharge of the GSA. CPCN argued that the actions of EE were contrary to section 65 of the Saskatchewan PPSA2 which requires that parties to a security agreement act "in good faith and in a commercially reasonable manner". Additionally, CPCN argued that the assigned security was subject to the terms of the original loan agreement and related debt documents which did not contemplate the prior unsecured loan between Eagle Eye and CPCN.
Following a review of case law in England, Australia, New Zealand and the United States, the court agreed with CPCN. It strictly construed the "all obligations" clause and determined that the amount required to discharge the GSA did not include the prior unsecured loan. In its decision the court cited several public policy reasons for not allowing EE's actions and noted:
- In exercising its rights under the GSA, EE had not been acting in good faith or in a commercially reasonable manner as required by the PPSA. Rather, EE had been acting to gain an advantage over the other shareholders in an oppression action;
- The "all obligations" clause in the GSA should be given a literal interpretation in order to limit the indebtedness secured to the indebtedness arising between the original parties to the original loan documents, and not to loans of third parties;
- A broad interpretation of an "all obligations" clause would be unfair to a debtor as a debtor would not reasonably anticipate that such a clause could be used by an unsecured creditor to convert itself into a secured creditor by virtue of obtaining an assignment of a security agreement;
- Permitting an unsecured creditor to transform unsecured debt into secured debt by way of assignment of a security agreement would have a destructive effect on the principle of pro rata sharing between unsecured creditors in bankruptcy law; and
- Allowing unsecured indebtedness to acquire priority over other secured claims through the assignment of a secured claim with higher priority would be inequitable to the debtor and would cause a disruption of traditional PPSA priorities. This would create uncertainty for other secured creditors in respect of their priority under future security agreements.
It remains to be seen whether Ontario courts will follow the Eagle Eye decision. As such, when planning any loan restructuring, creditors should be mindful that courts will likely not permit the conversion of unsecured debt into secured debt by virtue of an assignment of secured debt and underlying security documents.
Update on Bank Act Security Amendments
By: Christine Marchetti (Toronto)
In our last edition of Fully Secured (March 28, 2012 – Volume 3, No. 1) we reported on the upcoming amendments to the Bank Act contained in Bill S-5 (Financial System Review Act) which were designed to address the issue of priority as between registered security taken pursuant to Section 427 of the Bank Act and an unregistered (unperfected) security interest taken pursuant to the provisions of the provincial personal property security statutes across Canada. The amendments to Sections 425, 426 and 428 of the Bank Act contained in Bill S-5 were drafted to reverse the effects of 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.
As reported in our December 2010 issue, the Supreme Court had ruled in the Innovation and Radius cases that an unregistered security interest granted to a credit union by way of a general security agreement had priority over subsequent, but registered, Bank Act security granted to a bank. In each case, because the debtor had already granted a security interest in all of its present and after-acquired personal property to the credit union, the Court held that the debtor could not subsequently transfer an unencumbered interest in those assets to the bank.
The amendments have now received Royal Assent and came into force on May 24, 2012. As amended, Subsections 426(7) and 428(1) of the Bank Act now provide that the rights of a bank in respect of property subject to security taken and registered under the Bank Act will have 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". Subsection 425(1) of the Bank Act has also been amended to add a broad definition of the term "unperfected" which, in relation to a security interest, will refer to a security interest that has not been registered or publicized to third parties under the law under which the security interest was created.
British Columbia: The Dangers of Using the Prescribed Standard Mortgage Terms
By: Annie Siu-Fun Yu (Vancouver)
In the recent case of Kalsi v. Achary3, the British Columbia Supreme Court held that a mortgagee cannot recover payment from a party signing the mortgage as a guarantor when the terms of the guarantee were omitted from the mortgage, even though there was intent to give a guarantee.
The plaintiff was a private lender who lent money to the mortgagors (the "Mortgagors"), secured by a mortgage on the Mortgagors' home. The defendants were relatives of the Mortgagors, and they agreed to guarantee repayment of the mortgage money in the event of a default by the Mortgagors under the mortgage.
The mortgage was prepared by the plaintiff's lawyer. It was signed by the Mortgagors, and also by the defendants who were described as "guarantors". The terms attached to the mortgage (the "Prescribed Standard Terms") were those as prescribed under the Land Title (Transfer Forms) Regulation.4 They contained a definition of the term "covenantor" and provisions for the obligations of a covenantor, but none for a guarantor. The intended sachedule of guarantee terms simply never got attached.
The court considered the facts of the case and reviewed the Prescribed Standard Terms for a covenantor. The judge rejected the plaintiff's argument that by signing as "guarantors" the defendants had signed as covenantors. He noted the fundamental difference between the obligation of a covenantor and a guarantor: a covenantor's liability is primary like that of a co-borrower and a guarantor's liability is secondary to that of the principal debtor. He emphasized that because section 226 of the Land Title Act allows the Prescribed Standard Terms to "be modified by making additions, amendments or deletions", provisions relating to a guarantor could have been added to the Prescribed Standard Terms.
On this basis the court dismissed the plaintiff's case with costs, as there was insufficient evidence to identify the terms of any guarantee given by the defendants. The court also rejected the notion that the defendants' signatures on the form were sufficient to constitute a basic or "bare" guarantee.
The lesson from Kalsi is that the Prescribed Standard Terms should only be used as a template. Lenders preparing their own documents should ensure that conditions not specified in whatever standard mortgage terms they use are attached in a schedule to those terms. This is especially important as courts will not "fix" the mortgage terms or related schedules to reflect the actual intention of the parties. Similarly, financial institutions who have filed standard mortgage terms with the land title office should review and update their filed terms on a regular basis. This would help ensure that their filed terms are kept current, and include definitions and clauses for common mortgage transactions. In addition, as in Kalsi, to be effective the mortgages based on a lender's own filed standard mortgage terms must be amended as appropriate to reflect any terms of the loan and security which are not dealt with expressly in the filed standard terms.
Security on Commercial Licences: Developments Since the Saulnier Case
By: Ava Kim (Toronto)
In 2008, the Supreme Court of Canada ruled in Saulnier5 that a commercial fishing licence constitutes 'property' within the context of the Bankruptcy and Insolvency Act ("BIA") and the Nova Scotia PPSA6, thereby allowing the trustee in bankruptcy to seize the licence from the bankrupt. The Court recognized that although a fishing licence may not confer the full range of rights necessary to characterize something as 'property' under the common law, the licence did confer a bundle of rights sufficient to qualify it as property for the purposes of the BIA and the Nova Scotia PPSA. The bundle of rights conferred by the commercial fishing licence in Saulnier was found to be akin to a common law profit à prendre (an interest in land that gives the holder a right to enter upon another's land and take away something of value, namely, natural resources) since the licence provided a right to the fish and in turn, a right to the profits from the sale of the harvested fish. In this regard, the licence was not merely a right to do something that was otherwise unlawful.
Since then, the Saulnier decision has been followed and applied in similar cases involving commercial licences, and in one context, was given retroactive effect to apply to a proceeding that arose prior to the Saulnier decision.
In Chez Outdoors7, allocations to hunt game issued by the Alberta Professional Outfitters Society under the Wildlife Act were held to fall within the definition of 'property' under the Civil Enforcement Act. The court reasoned that the allocations were something more than a mere permission to do something otherwise illegal but rather, rationally linked through the licensing process to the entitlement acquired by the holder, both to hunt and to harvest the product of the hunt. The creditor was therefore permitted to seize and realize upon the allocations held by the judgment debtor.
In Caines8, the Saulnier decision was not only upheld but was given retrospective and retroactive effect. A commercial fisherman made an assignment in bankruptcy and was granted an absolute discharge on April 3, 2008. Prior to the bankrupt's discharge (and prior to the Saulnier decision), the bankrupt's commercial fishing licence was listed on his Statement of Affairs dated March 21, 2007 at an estimated realizable value of zero. The trustee's estimate of the fishing licence in the bankrupt's Statement of Affairs was based on the position taken by the Department of Fisheries and Oceans of the Government of Canada ("DFO"), that a commercial fishing licence could be revoked at any time and therefore could not constitute property. Although commercial fishing licences had considerable value when transferred contractually between commercial fisherman, there was no effective way to force the DFO to consent to transfers of licences by trustees to third parties in the context of bankruptcies and therefore they had no realizable value.
On December 22, 2009, the trustee filed a notice of motion seeking an order that the bankrupt's commercial fishing licence was vested in the trustee thereby permitting the trustee to sell the fishing licence for the benefit of the creditors of the bankrupt's estate. Although the bankrupt was discharged on April 3, 2008 based on the March 21, 2007 Statement of Affairs, the court held that the Saulnier decision should have a retrospective and retroactive effect because it constituted a clarification and declaration of the law as it existed and was not a development of new law. As such, at the time of the assignment in bankruptcy, the fishing licence was 'property' under the BIA and therefore vested in the trustee.
Finally in Genge9, the Saulnier decision was extended by the court which found that a commercial fishing licence was 'property' capable of being held in trust by one person for another by way of a constructive trust.
The Saulnier decision, and the decisions that followed, have affirmed that in the context of a bankruptcy or receivership proceeding, or under personal property security legislation, commercial licences, permits, allocations or similar rights that confer a profit à prendre constitute 'property' and are therefore subject to the potential right of a trustee, receiver or secured creditor to seize and realize upon the rights of the bankrupt in such 'property'. Despite this characterization as 'property', any sale of the licence upon a realization is still subject to all applicable government approvals provided for in the governing legislation.
On the other hand, whether agricultural quotas constitute 'property' for purposes of personal property security legislation and the BIA remains unclear. The case law is somewhat inconsistent and in many instances varies from province to province. Quotas generally give the holder the right to produce or sell a stated amount of a particular regulated good or product, which amounts can be adjusted from time to time by the applicable agricultural marketing board. As such, there is really no bundle of rights similar to that in Saulnier that flow with the quota. Perhaps due to the uncertainty, some provinces have passed specific regulations that allow some quotas to be pledged to certain financial institutions to support loans. Until the Supreme Court of Canada is called upon to directly consider quotas, the provincial variations will remain.
A Banker Asked Us: What is a "fondé de pouvoir" and Why do I need one in Québec Syndicated Loan Transactions?
By: Alain Lalonde (Montreal)
Q: What is a "fondé de pouvoir" and why do I need one in order to obtain security in Québec to support my syndicated loan transaction?
A: The expression "fondé de pouvoir" is used in Article 2692 of the Civil Code of Québec ("CCQ") which came into force on January 1, 1994. Article 2692 CCQ reads as follows:
"A hypothec securing payment of bonds or other titles of indebtedness issued by a trustee, a limited partnership or legal person authorized to do so by law shall, on pain of absolute nullity, be granted by notarial act en minute in favour of the person holding the power of attorney of the creditors."
The expression "person holding the power of attorney of the creditors" is translated in French by the words "fondé de pouvoir des créanciers".
The majority of the Québec lawyers and notaries consider that Article 2692 CCQ imposes the following structure for syndicated loan transactions in Québec: execution of a Deed of Hypothec in favour of the fondé de pouvoir before a Québec Notary, issuance of a collateral demand bond by the Borrower under the hypothec in favour of the fondé de pouvoir and pledge of the bond in favour of the fondé de pouvoir, acting for and on behalf of the initial lenders and all such persons who may, at any time, become lenders under the credit agreement.
In the context of a syndicated loan, the issuance of a bond will not be necessary if the indebtedness is already evidenced by a note, debenture, bond or similar instrument. As regards non-syndicated loans, the hypothec secures the obligations of the debtor under the commitment letter and/or the loan agreement and the issuance of a bond is not necessary.
Over the years, the drafting of Article 2692 CCQ has been criticized by numerous authors, practitioners and by the Québec Bar who have suggested amendments to this Article.
The use of the expression "person holding the power of attorney" is considered by numerous authors as being unfortunate. It gives the impression that the fondé de pouvoir is a simple agent (mandatary) and therefore Article 2692 CCQ would not be necessary since there are other provisions in the Civil Code of Québec dealing with the agency (mandate). This ambiguity has led some practitioners to conclude that the sole purpose of Article 2692 CCQ is to require the notarial form for the hypothecs securing payment of bonds or other titles of indebtedness.
The notarial act en minute is always required for immovable hypothecs (syndicated loans and non-syndicated loans). As regards movable hypothecs, the notarial form is not required for non-syndicated loans. The notarial act en minute requires that the representatives of the lender and of the debtor sign in the presence of a Québec notary. It is usual practice for lenders and debtors having their head office or place of business outside Québec to appoint a representative in Québec to sign on their behalf.
In a judgment rendered on October 3, 2008, the Honourable Judge of the Superior Court, Christiane Alary, has stated that, although there is only one creditor at the time of the execution of the hypothec, the hypothec securing the payment of bonds or other titles of indebtedness shall, on pain of absolute nullity, be granted by notarial act en minute in favour of the fondé de pouvoir.
Security Granted Following Payment Default Held to be Improper Preference
By: Richard Dusome (Toronto)
A recent Ontario case suggests that an unsecured creditor's forbearance in requiring payment, together with its offer of new payment terms for a debt, may not be sufficient to support an insolvent debtor's contemporaneous granting of security to that creditor.
In Snoek10, the Superior Court of Justice considered security granted to a group of individual creditors ("B") of the bankrupt borrower ("HSLP") in the context of a larger Ponzi scheme involving numerous unsecured creditors.11
B had initially advanced a series of unsecured loans to HSLP evidenced only by multiple promissory notes. When HSLP was unable to obtain additional Ponzi loans to service payments on B's loans, B made demand for repayment and asked for security. HSLP granted security to B in the form of an undivided interest in a mortgage asset held by HSLP, and in exchange B agreed to capitalize the unpaid interest, and to accept new promissory notes with a reduced interest rate and an extended term.
The Trustee moved to have the security granted to B set aside on the grounds that it constituted an improper preference under the Assignments and Preferences Act12. It was alleged that the security had been granted to B when HSLP was insolvent and with the intent to prefer B over other creditors.13
The Court initially concluded that the security constituted an improper preference under Section 4 of the Act as HSLP had clearly granted the security at a time when HSLP was insolvent. There was a clear intent to prefer B over several of HSLP's other creditors who were also demanding repayment from HSLP at the same time but did not receive similar security.
The Court then further concluded that B had not shown the characterization of the security as an improper preference was saved by virtue of one of the exemptions available under Sections 5(1) or 5(5)(d) of the Act. In particular, B had not proven that either (i) the security was granted for a present actual advance of money, or (ii) the security was granted for a pre-existing debt and B made a new advance to HSLP in the belief that the advance would enable HSLP to continue its business and pay its debts in full.
Madam Justice Mesbur determined that the Act requires an actual advance of money to satisfy the saving provisions, and noted that Section 5 did not expand the plain meaning of the term "money" or expressly contemplate any other types of consideration like money's worth or a forbearance. However, she questioned whether B's actions in continuing to demand payment actually constituted a forbearance, and therefore she did not technically have to determine if a proper forbearance could in any circumstances be sufficient to qualify as an advance of money. In addition, in her view there was no cogent evidence to support any reasonable belief that B's actions in capitalizing interest, reducing the interest rate and extending the term would mean that HSLP would continue in business and to be able to pay its debts in full. Madam Justice Mesbur accordingly concluded that the security given to B could not be saved and must be set aside.
The Court's strict interpretation of the Act may have been based upon a desire to prevent B from elevating its status to that of a secured creditor to the detriment of many other unsecured victims of the Ponzi scheme. It is not clear if the court's determination in this case would be applied in a situation where there was an existing secured institutional lender providing an operating line to a borrower where that lender received additional shore-up security in exchange for continuing to extend the line of credit. In that situation it would presumably be easier to establish that maintenance of the line of credit was essential to the borrower being able to continue its business and ultimately pay its debts in full. We understand that the case is presently under appeal14 and look forward to the Court of Appeal providing some clarification on this issue.
Spotlight on Security Documents: The Benefits of Forbearance Agreements - A Lender's Perspective
By: Christine Mason (Toronto)
Following the occurrence of a default by a borrower, a lender may have to quickly decide on the best course of action in order to protect its investment. If the default is minor, the lender may agree to waive the default, but a lender is less likely to agree to a waiver if the default is serious or a sign of looming problems. In the latter case, entering into a forbearance agreement with the borrower and its guarantors may offer the lender an attractive option.
By entering into a forbearance agreement, the lender agrees to refrain (or forbear) from exercising its rights and remedies under the loan agreement and related security documents for a certain period (the forbearance period) in exchange for certain acknowledgements and agreements from the borrower and any guarantors. From the lender's perspective, entering into a forbearance agreement has many potential benefits, whether or not the intention of the lender is to continue the lending relationship with the defaulting borrower at the end of the forbearance period or terminate the lending relationship. Some of these benefits are:
- Avoiding any argument by the borrower that the lender has waived the default(s), and therefore its ability to take enforcement action in respect of such default(s) at the end of the forbearance period, by including express statements in the forbearance agreement to this effect
- Avoiding the lender having to incur the time, cost and potentially adverse connotations of taking enforcement action, by giving the borrower the time to cure the default(s) or repay the lender, for example, by arranging alternative financing or an equity injection or selling assets with the lender's consent
- Giving the lender time to meet with its advisors to assess in more detail the financial position of the borrower and develop an enforcement strategy if the borrower is not able to cure the defaults or repay the lender at the end of the forbearance period
- Requiring the borrower to provide additional reporting to the lender, to enable the lender to better assess and monitor the ongoing financial performance and position of the borrower
- Allowing the lender to amend the terms of existing facilities, for example, by increasing the interest rates in certain circumstances, amending the repayment schedule and tightening existing or introducing new financial covenants
- Allowing the lender in certain circumstances to obtain additional fee income, by requiring the borrower to pay a forbearance fee
- Allowing the lender the opportunity to correct any deficiencies with the existing security package, or in certain situations where fraudulent preference concerns are appropriately addressed, take additional security and/or guarantees that were not previously available or forthcoming.
1 CPC Networks Corp v Eagle Eye Investments Inc, 2011 SKQB 436 (CanLII) ["Eagle Eye"]. Appealed on other grounds, 2012 SKCA 20.
2 Personal Property Security Act, 1993, S.S. 1993, c. P-6.2 ["Saskatchewan PPSA"].
3 2012 BCSC 361 ["Kalsi"]
4 Those prescribed standard mortgage terms have now been replaced by Schedule B of the Land Title Act (Board of Directors) Regulation, B.C. Reg. 332/2010
5 Saulnier v. Royal Bank of Canada, 2008 SCC 58,  3 S.C.R. 166. ["Saulnier"]
6 Personal Property Security Act (Nova Scotia) ["Nova Scotia PPSA"]
7 Stout & Co. LLP v. Chez Outdoors Ltd.,  A.J. No. 776 ["Chez Outdoors"]
8 Re Caines  N.J. No. 123 ["Caines"]
9 Genge v. Dredge, 2008 Carswell Nfld 292, 2008 NLTD 172. ["Genge"]
10 Harry Snoek Limited Partnership (Re), 2011 ONSC 6667.
11 The Trustee had initially challenged the security acquired by 3 groups of creditors. However, by the time the motion was heard, one group of creditors had settled with the Trustee, and one group did not appear on the motion, so the bulk of the court's decision was primarily focussed on the security granted to B.
12 Assignments and Preferences Act, R.S.O. 1990, c.A.3, as amended [the "Act"].
13 It would appear that the fraudulent preference provisions of the Bankruptcy and Insolvency Act (Canada) were not invoked by the Trustee because the security was not given within the 90 day period prior to the bankruptcy of HSLP contemplated by Section 95 of the BIA.
14 Counsel has indicated that the appeal is currently scheduled to be heard on November 1, 2012.
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.