Lenders often advance funds to borrowers, with the understanding that the borrowers may, in turn, advance money to other entities, subsidiaries, or assignees that have not yet been identified or do not yet exist. Such entities are therefore not in a position to grant security at the time the initial loan is established. This can leave a lender in a precarious position. To protect themselves, lenders often include a provision in term sheets or credit agreements requiring subsequent recipients of these funds to provide security. Unfortunately, imprecise wording or a lack of diligence can render such a provision ineffective and fail to provide a court with the tools it needs to order an equitable charge over the applicable assets.
This was the unfortunate situation facing a group of creditors (the Noteholders) in the case of League Assets Corp (Re)1. The Petitioners, known as the League Assets Group, were principally involved in real estate development. In 2012, League Opportunity Fund Ltd. (LOF) issued an offering of convertible promissory notes. The Noteholders that subscribed were provided with security in the form of a general security agreement with LOF, as well as a subscription agreement that outlined a form of future security: LOF would enter into loan agreements "with all investee companies, with any loans advanced by [LOF] secured by security agreements over the assets of the investee companies."
LOF subsequently transferred money to various League Assets entities, such as League Assets Corp. (LAC) and League Capital Markets Ltd. (LCM). To further complicate matters, LAC also advanced funds to various other entities (the Tier 2 Entities). None of the various League Assets entities ever provided any security to LOF. Only LAC provided loan documentation.
Business did not go well for LOF and the other League Assets entities. Eventually they obtained protection under the Companies' Creditors Arrangement Act2. The CCAA proceeding was not enough to prevent a complete liquidation process. In that proceeding the Noteholders sought 1) a declaration that certain League Assets entities were indebted to LOF, and 2) an equitable charge on the assets of those League Assets entities for the amount of indebtedness.
On the first issue, the BC Supreme Court held that there was little or no evidence that the money transferred by LOF to LCM and the Tier 2 Entities were "loans" as described in the subscription agreement. There were other plausible explanations for the transfers, such as repayment of debt. The transfers to the Tier 2 Entities in particular were problematic because they did not receive money directly from LOF, but through LAC as intermediary.
Having failed to obtain the declaration of indebtedness, the Court concluded that an equitable charge could not be granted. However, the Court noted that even if the money transfers were loans, the Noteholders still faced insurmountable problems. In order to grant an equitable charge over the assets of the League Assets entities, the Court had to be satisfied that there was a common intention between the parties to grant a security interest. In this case there was insufficient evidence to conclude that such a common intention existed between LOF and either LAC, LCM, or the Tier 2 Entities. The Court provided examples of what might have been considered acceptable, such as a signed defective general security agreement or draft documentation. None of those types of evidence were found here.3
The Court also expressed concern that if the Noteholders were correct in their arguments, many other stakeholders would advance similar arguments and the CCAA proceeding would "descend into chaos as each of the creditors, such as the Noteholders, attempt to jockey for a better and bigger piece of the pie". For all of the above reasons, the Noteholders failed in their application for a declaration that they held an equitable secured claim.
The takeaway messages are these. First, the language in any agreement to provide for the delivery of future security must be clear and unambiguous, and should be drafted so as to trigger an event of default if not delivered within a specified time. Second, the details of the future security itself (for example, a loan agreement and accompanying general security agreement charging all assets) must be clearly worded and comprehensively stated. Finally, the agreement to deliver the future security should be the subject of regular and sustained follow up to ensure the security is granted promptly after the triggering event occurs. Without all of the above measures, a lender may be left in a very precarious position.
1. League Assets Corp (Re), 2015 BCSC 42
2. Companies' Creditors Arrangement Act, R.S.C. 1985, c. C-36 [CCAA]
3. Even if such documentation had existed in this case, being forced to rely on such evidence is hardly an ideal situation for any creditor.
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