Suzanne Amielprof. Catherine Walsh

Suzanne AmielProf. Catherine Walsh

Secured TransactionsFall 2010

Secured Transactions Summary

Table of Contents

I.Introduction and Overview

John Armour, “The Law and Economics Debate About Secured Lending”

Sources of the Law on Secured Transactions

II.Formal and Functional Concepts of Security

1. Formal Concept of Security in the CCQ

A. The Hypothec

B. Sale with a Right of Redemption

C. Security Trusts

D. Instalment Sale

2. Functional Concept of Security in the PPSAs

Caisse Populaire Desjardins v. Canada – Federal (2009 SCC from FCA)

3. Case Study: Leases and Leasing

PPSA: Leases Functioning as Security Interests

CCQ: Leasing and Lease

4. Deemed Security Interests in PPSA and Extension of Publicity Requirements in CCQ

A. Assignment

B. Lease, Short Recap

C. Consignment

D. Sale Without a Change of Possession

5. Summary: Where Do We Look for the Law on Secured Transactions?

Quebec

Common Law Provinces

III.Creation of Consensual Security Rights

Introduction to the Creation of Conventional Security Rights

1. Limitations on the Ability to Create Security

A. Who Can Grant Security? Limitations on the Parties

B. What Can Security Be Granted in? Limitations on the Collateral

Saulnier v. Royal Bank of Canada – CML (2008 SCC from NSCA)

C. What Can Security Be Granted For? Limitations on the Purpose of Security

2. The Requirements for the Creation/Attachment of a Security Right

A. First Requirement: the Existence of a Secured Obligation

B. Second Requirement: Grantor Must Have Title to or Rights in the Collateral

C. Third Requirement: Objective Evidence of the Security Agreement

Rules for the Creation of Non-Hypothec Security Interests in the CCQ

IV.Third Party Effectiveness (Publication/Perfection)

1. Modes of Perfection/Publication

A. Delivery as a Mode of Perfection in the PPSA

B. Delivery as a Mode of Publication in the CCQ

2. Perfection and Third Parties: Overview of Possible Contests and Legislation

3. Perfection and Transferees

4. Perfection and Other Secured Creditors

5. Perfection and Unsecured Creditors or Judgment Creditors

6. Perfection and Parties Involved Upon Bankruptcy

PPSA: Priorities in Bankruptcy

Re Giffen – CML (1998 SCC from BCCA)

CCQ: Priorities in Bankruptcy

Lefebvre (Trustee of); Tremblay (Trustee of) – CVL (2004 SCC from QCCA)

Ouellet (Trustee Of) – CVL (2004 SCC, from QCCA)

7. Continuity of Perfection/Publication: Changing Modes of Perfection

8. Automatic Publication

V.Registration

1. Land Registries

2. Movable Registries

Characteristics of Movable Registries

3. Advance Registration

4. Multi-Agreement Registration

5. The Data Required in Registration

A. The Identity of the Grantor

B. The Identity of the Secured Creditor

C. Description of the Collateral

D. Duration

E. Maximum Value of the Obligation (only in Quebec)

6. The Effect of Errors in Registration

Re Lambert (OCA 1995) – CML

Exode Automobile Inc. (Syndic d’) (QCA 2005) – CVL

VI.Competing Claimants: Priority among Secured Creditors

1. The General Rule: First to Perfect/Publish Prevails

A. The General Rule for Priority among Secured Creditors in the PPSA

B. The General Rule for Priority among Secured Creditors in the CCQ

C. Successive Advances

D. Policy Justifications for First-to-Perfect Rule

2. The Exceptions to the General Rule

A. Purchase-Money Security Interest (PMSI)

Maschinenfabrik Rieter AG v. Canadian Fidelity Mills Ltd. (2005 QCCA) – CVL

B. Serial-Numbered Goods

C. Voluntary Subordination of Priority

D. Bank Act Security v. PPSA Security

Innovation Credit Union v. Bank of Montreal – CML (SKCA 2009)

Radius Credit Union Ltd. v. Royal Bank of Canada – CML (SKCA 2009)

VII.Droit de Suite: General Rule and Exceptions

The Secured Creditor’s General Droit de Suite

1. Exception One: Failure to Perfect/Publish

2. Exception Two: Authorized Sales

3. Exception Three: Sales in the Ordinary Course of the Seller’s Business

4. Exception Four: Serial-Numbered Goods

5. Exception Five: Low-Value Goods (NB ONLY)

VIII.Competing Claimants: Unsecured Creditors and Non-Consensual Secured Creditors

1. CCQ: Prior Claims

2. CCQ: Legal Hypothecs

3. Common Law Provinces: Non-Conventional Security Interests?

The Rights of Judgment Creditors

4. Competing Creditors Created by the BIA

A. By Demoting the Crown

B. By Trumping Provincially-Ranked Security Interests with Super-Priority Claims

C. By Barring Enforcement by Judgment Creditors

IX.Enforcement of Security on Default

1. Introduction to Enforcement of Security upon Debtor Default

What Constitutes Default?

2. Enforcement Remedies under Part V of the PPSA

A. Default

B. Reasonable Notice Doctrine

C. Self-Help by Secured Creditors under the PPSA

D. Remedy I: Sale (s. 59 NB)

E. Remedy II: Taking in Payment (s. 61(1) NB)

F. Remedy III: Receivership (s. 64 NB)

G. Remedy IV: Collection of Accounts Receivable (s. 57 NB)

H. The Grantor’s Rights in Enforcement Proceedings under the PPSA

I. What Property Right Does a Purchaser of a Seized Asset Get?

3. Enforcement Remedies under arts. 2748-2794 of the CCQ

A. Preliminary Measure a Hypothecary Creditor Must Take before Enforcing: Prior Notice

B. Surrender of the Property by the Debtor

C. Remedy I: Sale by the Creditor (arts. 2784-2790)

D. Remedy II: Sale by Judicial Authority (arts. 2791-2794)

E. Remedy III: Taking in payment (art. 2778ff)

F. Does This Enforcement Regime Apply to Other Creditors?

G. CCQ Enforcement Regime on Receivables: “Collection” (arts. 2743-2747)

I.Introduction and Overview

What is a Secured Transaction?

A secured transaction is a business arrangement by which a buyer or borrower gives collateral to the seller or lender to guarantee performance of an obligation, for example repayment of a loan (Black’s Law Dictionary)
Collateral is property offered by the debtor to back up the money he owes to the creditor
This property is what the CR can seize if the DB doesn’t pay the $$ back
The CR has no actual interest in the property itself  they want its liquidated value as an alternative form of repayment of the loan

Advantages and Disadvantages of Allowing Security Interests

Why does the law allow secured lending? See the Armour article below.
Lower risk situation created by the presence of security means secured creditors will charge a lower interest rate for the loan
This also partially explains why debtors grant creditors security  to get the lower rate
Debtors also grant security because they might not get the loan without doing so
Increase in the amount of credit available in the marketplace
Advantages of security to creditor:
1. Priority: the law respects the property right given to the creditor and gives them the first claim to the value of the liquidated asset
2. Increase in the likelihood of repayment
3. Gives creditor control and knowledge over their debtor’s asset
Unsecured creditors are to a certain extent dependent upon the secured creditor to monitor the debtor
Disadvantages of security:
Once a debtor grants security to one creditor, all other unsecured creditors are going to raise their interest rates because their loans are now higher risk (is this true?)

John Armour, “The Law and Economics Debate About Secured Lending”

Thesis: secured credit is socially beneficial and such benefits outweigh any social costs

What does secured credit do?

Essence of the institution of secured credit: a rule that one creditor is entitled to claim control over/ priority to payment from an asset as opposed to an open-ended set of other parties
Confers on the lender 2 entitlements:
1. Control of the collateral
If debtor not in default, control is negative (veto powers)
If debtor in default, control is positive (to seize and liquidate the collateral)
2. Priority of payment out of the proceeds of sale of collateral
From point of view of creditor, grant of security lowers default risk  reduced interest rate
Security tends to be used principally by smaller, younger, therefore riskier firms

Economic Theories of Security

Signalling Theory:A debtor who offers security to a creditor signals to them their seriousness about repaying, their creditworthiness  not borne out by empirical evidence
Monitoring Theory: the grant of security is a promise/bond by debtor not to engage in practices harmful to creditors’ interests, and creditor can check up on this (“agency costs”)
This reduces the probability of default, and increases the value of all creditors’ claims
Redistribution Theory: by borrowing on a secured basis, the debtor obtains a lower interest rate – by failing to adjust their rates in response to this increased risk, the debtor’s unsecured creditors bear the cost of this lower interest rate
This theory is not supported empirically – likely the benefits of security (i.e. increased monitoring) outweigh the costs

Domestic Laws and Secured Credit

Legal facilitation of non-possessory security and general security interests (over entirety of debtor’s assets) will increase the availability of finance, reduce risk of default (greater oversight)
Stronger enforcement rights stimulate lending at lower interest rates also
Subordinating some of the secured creditor’s claims to unsecured creditors’ claims will reduce the use of that type of security right

Informing Third Parties

All jurisdictions have a mechanism for bringing the existence of security rights to the attention of other creditors if they don’t publicize adequately, security right will not be enforced
Three strategies to reduce search costs of subsequent creditors:
1. Fixed list of security interests that one can create
2. Selective enforcement: secured creditor’s right is only enforceable v. third parties if their cost of publishing it was higher than the cost of the third party finding out the info for themselves
3. Public registry
Specific registration: only these types of security interests have to be published, with this informationStifles innovation in secured lending
Generic registration: define a security interest broadly, and say they have to be published with less informationPermits greater customization and innovation in the form of security arrangements

Concepts of Security Interests

Concepts of security vary in different places/jurisdictions
Can be called and conceptualized as a security right, or can be thought of as a title transfer
Hypothec v. mortgage: hypothec is called a security right, while mortgage was originally a conditional transfer of title (no longer really)

Types of Security Rights

Some security devices are consensual (contractual/conventional), some are legal (non-consensual, created by operation of law)

Publicity/Perfection & Third-Party Effectiveness

One publishes a hypothec/security right in QC; one perfects a security interest in CML provinces
Why do we require publicity/perfection?
1. To protect other secured creditors
Want to know if anyone else has a priority claim on the property
2. To protect unsecured creditors
One creditor would want to know if another creditor has a security interest in any of their common debtor’s property (changes risk assessment of loan)
3. To protect buyers
A person purchasing property would want to know if there are any security interests in the property, i.e. if someone could seize what they had bought
N.B. It is always a term in the security agreement that the debtor not sell the property they offered as security for the loan; but sometimes debtors breach
4. To help assess creditworthiness of a particular debtor
5. To guard against debtors giving security to unjustly preferred creditors, or fraudulently
N.B. a security can be given for a current obligation or a past obligation. We allow this because of business realities: if the assessment of the creditworthiness of the debtor changes, a lender with an ongoing loan obligation is exposed to more risk  so we allow the lender to take security to secure the performance of the past obligation
Do we really need publication?
A legal system could validly say that security rights are enforceable against people who know nothing about them
Nemodat quod non habet: you cannot give what you do not have
Third parties would only get what the seller (grantor of security) had left to give – an encumbered asset
Imposes transaction costs on third parties – they need to spend resources to find out if security rights exist
n.b. Germany operates without publication: just has a detailed set of priority rules
The opposite kind of legal system would protect good-faith third parties who purchase property encumbered by security rights they did not know – and could not know – anything about
Proper registration systems are essential to this type of system
Imposes transaction costs on the secured creditor  spend resources on publishing their right so as to make it enforceable against third parties

History of Publicity Requirements

Twyne’s Case (England 1604):
Facts: Twyne is a farmer who has not paid one of his creditors. Creditor of Twyne goes to the sheriff, asks him to seize Twyne’s sheep in lieu of repayment. Twyne says: “you can’t seize my sheep, someone else has a security interest in them.”
Issue: Who has priority to the sheep? Holding: The creditor who seized them.
Reasoning: because the first creditor left Twyne in possession of the sheep, it looks to the world like Twyne owns the sheep; the transaction was secret and could not have been discovered, so it was deemed fraudulent and therefore void.
Court is concerned with the “secret lien” – gives the insolvent debtor the opportunity to avoid their creditors by making up a prior security interest in favour of someone else
So unless SC takes possession of the property given in security, the transaction was deemed to be fraudulent
Ratio: need to take possession of security for security interest to be valid.
This philosophy dictated the CML on secured lending until the Industrial Revolution (200 years)
Need for non-possessory secured financing arose because the collateral the industrialists had to offer were the machines they needed for their business to run and make money
So the legislature intervened and created public registries: publication rebutted the presumption of fraud attending non-possessory financing transactions
None of this ever happened in Germany – non-possessory financing wasn’t prohibited
So no equivalent need for Legislature to establish a registry
So CVL in Germany has a NemoDat system
In North America, legislatures have always been committed to registration
Why? Settler societies – more anonymous market and mobile society (less trust).

Sources of the Law on Secured Transactions

1. Personal Property Security Acts (common law provinces/territories)
Brought into force starting in 1975 (ON) and ending in 2001 (Nunavut/PEI)
Model for PPSAs was Article 9 of the UCC (1972)
Grant Gilmore came up with organizing idea of Art. 9: the concept of the “security interest”  unifies the proliferation of different types of security interests into one functional definition subject to a uniform body of rules
This functional concept of security is replicated in the PPSAs to replace the huge variety of security interests that had come to be recognized in the common law
Registry systems are at the heart of the PPSAs
2. Civil Code of Quebec (Quebec)
Quebec also recognized a number of individual security interests  “numerusclausus”
Was complex: came to be at competitive disadvantage for interjurisdictional transactions
In 2004, CCQ was reformed and the hypothec became the principal security device in CCQ
Governs both moveable and immovable security interests
Complication: other Titles in CCQ recognize different security interests (trust, SWAROR)
So if a security interest comes in a form other than a hypothec, have to go to a different part of the Code to find the rules applicable to that transaction
3. Federal Secured Transactions Law
Bank Act Security (s. 427 of the Bank Act)
Allows banks to take security in business assets
This is a full-fledged security regime at the federal level
The coexistence of the provincial and federal regimes creates much confusion
It was enacted to fill a void in QC law: allowed bank to take non-possessory security when QC law didn’t have a similar security device (gap no longer exists, however)
Whether this security should exist is a current controversy:
Encourages banks to pick the regime most favourable to them in a particular case
Encourages banks to take security under BOTH regimes (no longer allowed)
Ships Registry: mortgages, etc. on ships are registered under a federal statute
Maritime Law: provides a lot of security rights at sea (by operation of law), ex. “salvage lien”
Railway Act: mini-secured lending regime on rolling stock
Intellectual Property Rights: trademarks/copyright registries
Indian Act: creditors are not permitted to seize assets located on reserves
4. International Covenants on Secured Lending
Capetown Convention on International Interests in Mobile Equipment (hasn’t been adopted yet)
Sets up a secured transactions regime and a registry for mobile equipment that moves between states (ex. aircraft; railway cars; space assets)
There have been changes to the Canadian insolvency act to accommodate this treaty
UNIDROIT was not able to achieve real agreement on many of the issues because the systems in place in different countries are so radically different
Have a skeletal convention that allows each country to develop their own position on issues
Is more of a model law (departure from what UNIDROIT normally does, which is harmonization endeavours)
UNCITRAL Legislative Guide on Secured Transactions
Some of these are soft law, but could trump Canadian law if we sign on

II.Formal and Functional Concepts of Security

1. Formal Concept of Security in the CCQ

A. The Hypothec

Definition of a hypothec:

art 2660 / A hypothec is a real right on a movable or immovable property made liable for the performance of an obligation. It confers on the creditor the right to follow the property into whosever hands it may be, to take possession of it or to take it in payment, or to sell it or cause it to be sold and, in that case, to have a preference upon the proceeds of the sale ranking as determined in this Code.

The civil law interpretation might be that if you want security for the performance of an obligation, you have to use the legal instrument of the hypothec – this is the one provided by the Code
But this is not the right assumption – the CCQ recognizes a number of different institutions that are ways to create security rights
But subjects them to the rules for publicity (and sometimes enforcement) in the book on hypothecs
Difficulty: figuring out the relationship between the two regimes

B. Sale with a Right of Redemption

art 1750 / A sale with a right of redemption is a sale under a resolutory condition by which the seller transfers ownership of property to the buyer while reserving the right to redeem it.
A right of redemption in respect of a road vehicle or other movable property determined by regulation, or in respect of any movable property acquired for the service or operation of an enterprise, has effect against third persons only if it has been published; effect against third persons operates from the date of the sale provided the right of redemption is published within 15 days. As well, the transfer of such a right of redemption has effect against third persons only if it has been published.