September 2012 

In November of 2010, The Supreme Court of Canada held that where a provincially governed (Personal Property Security Act) security interest came in conflict with a security assignment taken by a chartered bank under the Bank Act (Canada), that is, where both the security interest and the security assignment covered the same property with each secured party claiming priority for its respective interest, the priority rules set out in the Bank Act did not provide an answer to the question, at least for the fact situations in the two cases the Court then considered.  In these two cases (the "Innovation Case" and the "Radius Case", hereinafter, collectively, the "Previous Cases"), in essence, the Court held that, due to the constitutional primacy of the federal Parliament over the provincial legislature, a provincial Personal Property Security Act could not set out rules to solve priority disputes; the Bank Act did set out rules for determining priority between these types of interests in some situations, but not the situations in the Previous Cases.

In both of the Previous Cases, a credit union took a provincially governed personal property security interest in certain collateral and failed to register notice of same in the appropriate Personal Property Registry.  Thereafter, a chartered bank took a Bank Act, Section 427 security assignment affecting the same property, and the bank did everything it was supposed to do under the Bank Act to establish the priority of its security assignment (including filing a Notice of Intention by the debtor to grant the security assignment to the bank in the appropriate registry office).  The Court held that the fact that the credit union had not registered a financing statement under the Personal Property Security Act did not adversely affect its priority position vis-à-vis the bank with respect to its Bank Act security assignment, because (as noted above), the Bank Act did not provide a rule to determine priority in this particular situation.  The Court then went back to basic principles to determine priority, including concepts such as "first come, first served" and "once you've given away all your rights in property, you have nothing further to give to anyone else".

The result of the Previous Cases was to put chartered banks taking only Bank Act security in a difficult position.  Even where a bank searched the debtor's name in the appropriate Personal Property Registry, the bank will not find any record an unregistered provincially governed security interest against the debtor's name.  In an earlier paper dealing with the Previous Cases, the writer suggested that one solution to this dilemma would be for a bank to take both Bank Act security and Personal Property Security Act security.  However, by far, the best solution would be for Parliament to amend the Bank Act to provide an appropriate priority rule for this situation.  This has now been done.

Sections 426(7), 426(7.1), 428(1), 428(1.1) and 428(2) of the Bank Act now make it clear that where a provincially governed security interest is not duly registered ("perfected"), a properly taken and subsequently acquired Bank Act security assignment will prevail over the charged secured property.  The legislation does however make it clear that if a bank takes a Bank Act security assignment with the knowledge that the affected collateral is already subject to a previously created but unregistered provincially governed personal property security interest, then the bank's security will be subordinate.  In the Previous Cases, the debtors, either intentionally or unintentionally, did not advise the banks of the previously granted provincially governed security interests.  Thus the banks didn't know about the pre-existing security, and searching in the Personal Property Registry would have told them nothing.

This is a big improvement in the law of secured debt transactions.

March 2009 

On October 29, 2008, the Manitoba Court of Appeal delivered its decision in Re Ehrmantraut (Bankrupt), 2008 MBCA 127, affirming the Manitoba Queen's Bench judgment delivered on May 13, 2008 (the "Ehrmantraut Case").

This case involved a situation where a father wished to acquire certain improved real estate (the "Realty"). The father needed mortgage financing in order to complete his acquisition, but could not get same unless the lender also obtained the benefit of the father's son's covenant to repay the loan. The lender could have allowed the Realty to be put in the father's name alone and got a separate guarantee undertaking from the son, but instead, the lender stipulated that both father and son be put on title as owners/mortgagors. Although not stated as such in the Ehrmantraut Case judgment, one can only assume that the lender believed that the son's covenant to repay would be less likely to be avoided if the son was also shown on title as having an interest in the Realty. Financing was provided, the acquisition closed and father and son were listed on title as joint tenants.

Sometime later, the son became bankrupt and the son's trustee in bankruptcy found that the son's estate included the son's interest in the Realty or the value thereof. In support of the trustee’s position it was submitted that:

(i) a Declaration as to Possession for the Realty was sworn and signed by both the father and the son, containing declarations that they were both entitled to be registered owners in fee simple in possession of the Realty;

(ii) a Statement of Affairs was sworn by the son, declaring his joint interest in the Realty; and

            (iii) by pledging his credit, the son had given good value for the joint interest in the Realty.

The father opposed, maintaining that the son's joint interest in the Realty was held as trustee for his father. In support of the father's position, it was submitted that:

(i)         the Realty was leased and all of the rentals were deposited to the father's bank account (presumably, with the son not objecting to this arrangement);

(ii)        the son did not advance monies either for the purchase of the Realty or to cover its maintenance costs;

(iii)       the father made all of the mortgage loan payments and paid all expenses required for/related to the Realty;

(iv)       the father paid income tax on the rental income derived from the Realty; and

(v)        the arrangement between father and son was simply that the son was "lending his (the son's) name to enable me (the father) to obtain financing and that I (the father) would pay all the expenses for the purchase of (the Realty) and would be the beneficial owner of (the Realty)".

After reviewing the evidence, the Madam Justice McKelvey of the Court of Queen’s Bench (the “Court) noted that there was also no evidence of a (written) trust agreement/arrangement/declaration and no caveat had been registered against the title to the Realty giving notice of the father's alleged trust.

The Court held that although the above-described evidence (including the father's evidence of the intentions of himself and his son) suggested the possibility of a trust arrangement, there was insufficient evidence presented to convince the Court to hold that a trust did in fact exist. The Court suggested certain other possible indicia which could have been put forward (which were not presented by either the father or the trustee in bankruptcy) to argue for the existence of a trust, which included an affidavit from the son, an affidavit from the lawyer who handled the Realty acquisition transaction, an affidavit from an individual employed by the lender at the financial institution involved, an acknowledgement that the son received independent legal advice, an indemnification agreement by the father covering the son should the son be called upon to pay any of the mortgage payments and/or a caveat registered against the title to the Realty giving notice of the trust's existence. The finding of no trust meant that the son's interest in the property was both legal and equitable, and was thus available to the son's creditors in the son's bankruptcy. The Court also found that the son had given valuable consideration to the father (for acquiring his interest in the Realty) by pledging his credit as a mortgagor/owner.

The Ehrmantraut Case suggests that where someone is to be on title as an owner (or part owner) of real property and the arrangement is that such person is not to have any true or beneficial ownership interest in the property, the trust arrangement should be clearly documented and the beneficial owner (or owners) should register notice (by caveat) of their true or beneficial ownership interest in the property.

Express written trusts (and frequently trust notification caveats) are in fact frequently put in place by solicitors acting for one or more true or beneficial owners who decide to take title to real property in the name of a bare trustee corporation. However, in the Ehrmantraut Case, the son's bankruptcy trustee raised another challenge to the alleged trust's existence which frankly, this writer has never heard of or considered. This argument is based on the "indefeasibility of title/ownership" rule found in Section 59(1) of The Real Property Act (Manitoba)(the "MRPA"). Section 59(1) is, in this writer's opinion, at the very core and is of the essence of the MRPA's rules and concepts relating to the ownership of titled real property as it deals with the essential nature and extent of real property ownership. It is worthwhile to set it out in full:

59(1) Every certificate of title, so long as it remains in force and uncancelled, is conclusive evidence at law and in equity, as against Her Majesty and all persons, that the person named in the certificate is entitled to the land described therein for the estate or interest therein specified, subject, however, to the right of any person to show that the land is subject to any of the exceptions or reservations mentioned in section 58, or to show fraud wherein the registered owner, mortgagee, or encumbrancer, has participated or colluded and as against the registered owner, mortgagee, or encumbrancer; but the onus of proving that the certificate is so subject, or of proving the fraud, is upon the person who alleges it.

The trustee in bankruptcy argued on this point that since the existence of a trust is not specified as an exception to the declaration of ownership rights in Section 59(1), registered ownership by a person with a title under the MRPA cannot in law be subject to a trust (for the benefit of one or more off-title owners). This argument was bolstered by reference to certain rules/requirements in Sections 49(2) and 81(1) of the MRPA, which say, in effect, that a Land Titles Office is not, except in certain specified situations which don't concern us here, to make entries on a title or in the register of any trusts or the existence of any trusts, whether "expressed, implied or constructive".

Fortunately for the sake of persons (and their counsel) who have utilized and will in the future wish to continue to utilize express (typically "bare") trusts for the holding of title to real property, the Court appeared to disagree with this argument. The writer uses the word "appeared" here because the Court of Appeal did not specifically deal with this issue, and the trial judge seems to have dealt with the issue somewhat inconsistently.

Notwithstanding the holding in the Ehrmantraut Case - and perhaps due to the Court's lack of unequivocal pronouncements on the effect of Section 59(1) of the MRPA in the context of trusts - the writer is concerned that either in Manitoba or in another Canadian jurisdiction which has statutory language dealing with titled ownership similar to that quoted above, sometime in the future, a court may hold that the combination of these three sections does in fact bar the recognition or imposition of a trust on titled real property. Current Manitoba Land Titles system practice is in fact to permit a caveat to be registered against a title giving notice of a trustee -beneficial owner(s) relationship. But is such practice in fact contrary to Sections 49(2) and 81(1) of the MRPA? Presumably, the basis of the rules in Sections 49(2) and 81(1) is that the government doesn't want Land Titles personnel to have to review the (perhaps lengthy and complex) documents creating express trusts, whether with respect to the existence of the trust or as to the trustees' rights and powers thereunder so as to ensure that a particular dealing by the registered owner is in compliance with the obligations of the trustee(s) under the trust.

Perhaps the MRPA could be amended so as to confirm current Land Titles practice, but make it clear that registration of a caveat giving notice of a beneficial owner-trustee relationship (i) does not obligate the Land Titles system to review and ensure compliance with the limitations and powers on and held by the trustees (or even to ensure the existence of the trust), and (ii) does not of itself confirm or validate the existence of the "alleged" trust, nor constitute a confirmation that any particular dealing with the property by the registered owner thereof (the "alleged" trustee(s)) is authorized under the terms of the trust, these matters to be capable of being challenged by all interested parties. Currently, this is the situation with caveats in that someone who wishes to challenge the validity of the right, claim, or interest of which a registered caveat gives notice is entitled to bring the matter before a Court and argue the merits of the right, claim or interest in that forum.

February 2011

The answer to the question posed in the heading of this paper is “sometimes”.  As unsatisfactory as such answer may be (from the point of view that predictability of the outcomes of legal questions should be an important feature of our legal system), it is necessary to keep in mind three rules found in the Personal Property Security Act (the “PPSA”):

(i)            the principles of common law, equity and the law merchant, except insofar as they are inconsistent with the provisions of (the PPSA), supplement (the PPSA) and continue to apply;

(ii)           the rights, duties and obligations arising under a security agreement, under (the PPSA) or under any other applicable law shall be exercised or discharged in good faith and in a commercially reasonable manner; and

(iii)          a persondoes not act in bad faith merely because the person acts with knowledge of the interest of some other person.

Generally, the PPSAs are intended to establish a regime where the priority of competing security interests can be clearly and easily determined. Thus, the general rule is that if you have a security interest and you want to come out ahead of any competitors, you had better register promptly (before a competitor registers) and, you had better register properly (in accordance with the rules for registration under the Act and its Regulations).

But what if a security interest is acquired by a creditor (“Creditor # 1”) who knows that another pre-existing secured creditor (“Creditor # 2”) has not registered, or has improperly/erroneously registered, with the result that Creditor # 1 ends up with an unexpected benefit, advantage or windfall?

Clearly, the third of the above quoted rules would appear to give Creditor # 1 an unexpected benefit where Creditor # 1 knew of the existence of Creditor # 2’s security interest and Creditor # 1 took advantage of Creditor # 2’s failure to register knowing that Creditor # 1’s registration would – in the absence of Creditor #2 properly registering – rank ahead of Creditor # 2’s interest.  Something more than mere knowledge on the part of Creditor # 1 (of the pre-existing security interest held by Creditor # 2) is required in order to subordinate Creditor # 1 to Creditor # 2.  In essence, that “something more” must comprise one or both of:

(a)          inequitable conduct (in the eyes of a Court) on the part of Creditor # 1; and/or

(b)          bad faith (in the eyes of a Court) on the part of Creditor # 1.

The application of these rules is illustrated in these three cases:

1. The Furmanek v Community Futures case (The “Furmanek Case”), British Columbia Court of Appeal.  In the Furmanek Case, the vendor of a business “took back” a security interest in the purchaser’s assets and made a proper registration of its security interest in the Personal Property Registry.  The purchaser paid part of the purchase price in cash which it borrowed from Community Futures Development Corporation of Howe Sound (“Development”) and Development also registered its security interest in the Personal Property Registry, but in so registering, Development erroneously omitted to refer to the purchaser’s inventory in its financing statement.  When the purchaser failed to pay what it owed, a contest arose between the vendor and Development as to who had priority over the purchaser’s inventory.  The vendor (for obvious reasons) argued that the PPSA required that a secured party strictly comply with the applicable registration rules, failing which it should not be considered to have perfected its security interest, or, in other words, it should not be entitled to priority as against the vendor’s proper registration.  Development argued that it was always understood by all parties concerned that Development was to have a first charge on inventory.  The Court noted the following facts:

(a)          the vendor knew that without Development’s financing, the sale and purchase transaction would not have been completed;

(b)          the vendor was actively involved in the negotiations between the purchaser and the Development leading to provision of the Development financing, and the vendor represented to Development that the assets being acquired by the purchaser from the vendor were “free and clear” and that accordingly, Development expected to obtain a first charge on the inventory;

(c)          the vendor knew that if Development did not obtain a first position on the purchaser’s inventory, Development would not provide financing; and

(d)          in the sale and purchase agreement between the vendor and the purchaser, the security interest granted by the purchaser back to the vendor for part of the purchase and sale price was referred to as a “second mortgage”.

The Court held in favour of Development. On the basis of the facts in the Furmanek Case, justice was done as it was manifestly unfair to allow the vendor to take advantage of Development’s registration omission.  However, the Court based its decision on more than just what seemed fair or unfair.  In particular, the Court held that:

(i)            while generally speaking, registration of a security interest with knowledge of a prior unregistered security interest will not of itself constitute bad faith or operate as an estoppel against the registering party, the circumstances in the Furmanek Case went “beyond mere knowledge of the fact that Development was asserting a prior interest”;

(ii)           although the vendor did not expressly agree to subordinate its security interest in favour of Development’s security, the PPSA makes it clear that a secured party may subordinate its interest in ways other than inclusion of a subordination provision in a security agreement.  The statute provides that “Any secured party may, in a security agreement or otherwise, subordinate his or her security interest to any other interest…”; and

(iii)          in light of the first of the above stated rules, PPSA priorities may be determined by the application of equitable principles.

            The Court held that on the basis of the vendor’s knowledge and its conduct, the vendor’s security interest in the purchaser’s inventory was equitably subordinated to Development’s interest.

                        Note:

(A)          the Court pointed out that its decision in the Furmanek Case was simply another in that long line of cases where the Courts have held that an act of a legislature will not be permitted to be utilized as an instrument of fraud.  In doing so, a Court does not hold invalid the legislature’s legislation, rather, on the basis of equity, it imposes an obligation on the individual who is seeking to take what the Court believes to be an inequitable advantage against one or more others on the basis of the strict operation/application of the legislation;

(B)          the vendor’s knowledge and unfair conduct would not have protected Development if an innocent third party was involved.  Thus if the vendor had sold its debt claim and security interest to a bona fide assignee, that assignee would almost certainly be entitled to hold priority over Development (some might argue that an assignee would and should acquire its interest "warts and all", no doubt on the basis that the PPSA provides that an assignee of a security interest takes the assigned security interest, essentially, "as is", as to the matter of perfection, but in this scenario, there was nothing wrong with the vendor's perfection, the problem being the vendor's inequitable conduct vis-a-vis Development, something that an assignee would not be "guilty" of); and

(C)         the Court of Appeal observed that another possible rationale for holding that Development had priority over the vendor would be on the basis of an implied agreement or undertaking by the vendor to subordinate its security position to that of the Developer.  In this regard, remember the above-noted factual holding that in the purchase and sale agreement, the vendor referred to its security interest as a “second mortgage”.

1. The Canadian Imperial Bank of Commerce v. A.K. Construction (1988) Ltd. Case (the “CIBC Case”), Alberta Court of Queen’s Bench.

In the CIBC Case, CIBC and RoyNat both loaned money to two debtor corporations related to each other (collectively, the “Debtor”) for the purpose of enabling the Debtor to acquire certain heavy construction equipment.  The equipment was “serial numbered goods” under the PPSA and its Regulations, but only CIBC properly registered its security interest against the serial numbers, RoyNat omitting to register against the serial numbers.  The Debtor became insolvent, the equipment was sold and a contest arose between CIBC and RoyNat as to who was entitled to the proceeds of sale.  CIBC argued that it had done what it was supposed to do under the legislation and RoyNat had failed to do what it was supposed to do, with the result that CIBC should be entitled to the proceeds of sale, not RoyNat.  RoyNat argued that there was an underlying understanding between CIBC and RoyNat to the effect that RoyNat was to have a first charge on the Debtor’s equipment and CIBC was to have a first charge on the Debtor’s accounts receivable and inventory.  There was at least one meeting between representatives of CIBC and RoyNat at which they discussed their respective security positions. However, the Court held that CIBC did not undertake to subordinate its security interest in favour of RoyNat (or treat RoyNat’s security interest as holding priority over CIBC’s security interest) so as to bar itself from relying on its (CIBC’s) rights under the legislation. The Court observed that knowledge held by CIBC of the existence of RoyNat’s security interest and its knowledge that if RoyNat had properly registered its security interest, it would have held priority over CIBC’s security interest (which had not been properly registered) was not sufficient to constitute “bad faith”.  For CIBC to have been subordinated to RoyNat, RoyNat would have had to have established something more which would constitute a waiver or an estoppel argument or involve CIBC in some nefarious conduct such as misleading RoyNat or hindering it in the perfection of its security interest. None of these could be “fastened” on CIBC in this case.

1. The Carson Restaurants International Ltd. v. A-1 United Restaurant Supply Ltd. (the “Carson Case”), Saskatchewan Court of Queen’s Bench

In the Carson Case, the priority contest was between:

(a)          the debtor Yorkton Restaurant as franchisee (being a corporation controlled by a Mr. Dennis A. Skuter, hereinafter, “Skuter”), the secured party, Carson as franchisor (also a corporation controlled by Skuter), the secured party Shonavan (also a corporation controlled by Skuter) and Mr. Dennis Skuter himself (collectively, the “Skuter Group”); and

(b)          A-1, being a secured party of the debtor with no connection to Mr. Skuter.

The sequence of events involving these parties was as follows:

(i)            In September of 1986,Carsonacquired a security interest in Yorkton Restaurant’s present and after acquired personal property;

(ii)           In April of 1987, A-1 acquired a security interest from Yorkton Restaurant covering goods provided by A-1 to Yorkton Restaurant on credit;

(iii)          In June of 1987, with Yorkton Restaurant being in default in the payment of its obligations owed to A-1, A-1 demanded payment and following that demand, there was a meeting between representatives of A-1 and Dennis Skuter.  Mr. Skuter assured A-1’s representative that Yorkton Restaurant would pay its debt to A-1;

(iv)         In July of 1987, A-1 registered its security interest but misdescribed Yorkton Restaurant’s name in its registered financing statement;

(v)          On October 1, 1987, Shonavan, in anticipation of selling certain equipment to Yorkton Restaurant on credit and taking a security interest therein, obtained a PPR search of Yorkton Restaurant’s correct name, which of course did not reveal A-1’s security interest which had been registered against Yorkton Restaurant’s incorrect name;

(vi)         On October 26, 1987, Carsonregistered its security interest against Yorkton Restaurant’s correct name, and on the same day, Shonavan also registered its security interest against Yorkton Restaurant’s correct name;

(vii)        In November of 1987, Mr. Skuter registered his own security interest against Yorkton Restaurant’s correct name;

(viii)       On January 20, 1988, with Yorkton Restaurant being in default of its obligations owed to Carson, Carson seized all of Yorkton Restaurant’s assets; and

(ix)         On January 26, 1988, A-1 amended its PPR registration to correct the name of Yorkton Restaurant.

The Court held that as between A-1 and the Skuter Group, A-1 should prevail.  The Court noted that fraud was not alleged against Mr. Skuter or the Skuter Group.  Nevertheless, the Court observed that “…in (these) circumstances…, to permit (the Skuter Group) through Skuter, to use (the PPSA and its registry system) has an instrument to defeat a claim of which (Skuter) was not only aware, but which he deceitfully delayed by his representations to A-1 when it was pursuing its security interest against Yorkton Restaurant on or about June 18, 1987 (emphasis being the writer’s here), would be inequitable. Accordingly, the priorities which would otherwise result from a strict application of the legislation should not hold and should be overturned by the application of equitable principles. 

What is interesting about the Carson Case is that the facts as spelled out in the decision do not themselves indicate that Mr. Skuter made deceitful representations to A-1 at the time of the June 18, 1987 meeting.  However, we can only assume that such deceitful representations were in fact made and that they were made by Mr. Skuter with the objective of inducing A-1 to not take the steps necessary to achieve PPSA priority for A-1’s security interest.