Canada: Assignments Of Conditional Sale Contracts

In the automotive industry, it is common practice for a car dealer to enter into a lease or conditional sales contract with a customer and then assign the right to receive the stream of payments from that contract to a financing company. However, this type of transaction, if not carried out properly, may create risk for the financing company as a result of the provisions of the Personal Property Security Act (the "PPSA"). If the financing company does not perfect its security interest under the PPSA, it may lose its right to the stream of payments if the dealer were to go bankrupt.

Section 2(b) of the PPSA provides that, subject to certain exceptions, the PPSA applies to a transfer of an account or chattel paper even if the transfer does not secure payment or performance of an obligation. Chattel paper is defined in the PPSA as a document that evidences both a monetary obligation and a security interest in or a lease of specific goods. This is the case with leases and conditional sales contracts. Pursuant to section 20(1)(b) of the PPSA, a trustee-in-bankruptcy has priority over unperfected security interests. Thus, the financing company purchasing the stream of payments under a lease or a conditional sales contract will need to perfect the assignment from the dealer. Perfection with respect to these types of instruments can be carried out by either registration or possession. In the current environment, possession is not usually practical, as the financing company would need to possess the only original copy of the contract, and it is often the case that multiple original copies are signed. As such, perfection by registration is usually a better option. This may still cause complications for the financing company, as PPSA searches then need to be done and any necessary waivers obtained. When a financing company deals with hundreds or even thousands of dealers, this can become prohibitively expensive and time–consuming.

But will perfection always be necessary in these types of transactions? The case of Re Fifth Dimension Technologies Inc.1 involved a somewhat similar situation in which Hewlett-Packard ("HP") defeated the claim of a trustee-inbankruptcy by successfully arguing that the PPSA should not apply to the transaction in question. At first blush, the case might seem to have application to the automotive context; but upon further analysis, it becomes clear that the exception used by HP in this case would not apply to the types of transactions that normally take place in the automotive industry. Perfection against a dealer is still necessary. Nevertheless, the case presents an alternative way to structure transactions that would make PPSA registration unnecessary.

The facts in Fifth Dimension are somewhat complex due to the nature of HP's distribution system. The government wished to lease some HP computer equipment for some of its Indian and Northern Affairs offices; but HP's distribution system forced this type of computer equipment to be sold to authorized distributors, who then sell it to resellers, who then sell it to the end user. The government was unable to purchase the equipment directly from HP or the authorized distributors. One reseller, Fifth Dimension Technologies (5D), won the contract with the government. Thus, after HP sold the equipment to the distributor, 5D purchased the equipment from the distributor. In order to facilitate this purchase, HP provided funds to 5D slightly in excess of the purchase price. 5D later went bankrupt, and the trustee-in-bankruptcy argued that the funds transferred from HP to 5D were a loan that would engage the PPSA. On the other hand, HP argued – and the court ultimately accepted – that HP was purchasing the equipment back from 5D and then leasing it to the government. In other words, HP had sold the computer equipment to the distributor, who sold it to 5D, who then sold it back to HP for a profit.

HP's argument in Fifth Dimension was heavily supported by the facts. This type of transaction was commonplace for HP, which was happy to provide a profit margin to resellers like 5D because the resellers had gone through the work of finding customers. In fact, the inclusion of a profit margin for 5D in the funds paid to it indicates an outright purchase, since it would make no commercial sense to loan 5D a profit margin. The relevant documentation, including financial records, invoices and a trust agreement signed by 5D and HP, along with the actions of the parties and the lack of any loan documentation, made it clear that the transaction was meant to be an outright sale. Justice Polowin also found the firsthand evidence of HP's employees more credible than the hearsay testimony of the trustee-in-bankruptcy.

This finding on the nature of the transaction is important because section 4(1)(i) of the PPSA provides an exception to the application of the PPSA that applied to this situation. Section 4(1)(i) provides that the PPSA does not apply to an assignment of an unearned right to payment to an assignee who is to perform the assignor's obligations under the contract. This exception contemplates the replacement of one account holder for another – similar to the replacement of one secured party for another. Thus, there is no need for registration because the underlying transaction will already have been registered under the PPSA (or, if there was no reason to register initially, then there will be no reason to register upon assignment).

Fifth Dimension is one of the only reported cases to use this provision of the PPSA to prevent the statute's application. The key difference between this case and the transactions that would normally take place in the automotive industry is that HP purchased the equipment outright and then leased it to the customer, rather than merely purchasing the right to a stream of payments. This would mean that, in our automotive example, the financing company would need to purchase title to the car – which is usually undesirable for a number of reasons relating to liability, insurance and tax. Thus, although this case presents an alternative way to structure transactions, a financing company purchasing the right to streams of payments under conditional sales contracts from a dealer will still need to register its security interest against the dealer, or else structure the transaction as a loan and security agreement directly with the underlying consumer.

Footnote

1 Re Fifth Dimension Technologies (2002), 4 PPSAC (3d) 31, [2002] OJ No 1260 (Ont SCJ).

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