January 2011

A financial institution takes security from a business debtor on all of the debtor’s presently held and after-acquired personal property.  At the time of the entering into of the security agreement, either the financial institution is aware of the fact that the debtor owns one or more serial numbered goods and completes its financing statement accordingly (filling out the correct particulars, including the serial number or numbers, of the serial numbered good(s)), or, the debtor owns no serial numbered goods and the financial institution’s financing statement accordingly contains no particulars of any serial numbered goods.  At some point in the future, the debtor does acquire one or more serial numbered goods but this is not communicated to the financial institution, whether inadvertently or intentionally.  Subsequently, the debtor becomes insolvent or bankrupt and the financial institution decides to realize its security.  Consider the following:

(i)            with respect to the after-acquired serial numbered goods, does the financial institution have valid and enforceable security against same, as between the financial institution and the debtor?

(ii)           what is the financial institution’s position if, after the financial institution registered its financing statement, the debtor granted a security interest in its after-acquired serial numbered goods to another secured party who did properly register a financing statement against the serial numbered goods?

The answer to the first question is quite clear – because the rules regarding the need to properly register against serial numbered goods relate to establishing the secured party’s priority against persons other than the debtor (ie it pertains to “perfection”), as between the financial institution and the debtor, the security interest is enforceable against the debtor.

What about the financial institution’s security (with respect to the serial numbered goods) as against the subsequent secured party (who did properly register against the serial numbered goods)?  This question was answered – in favour of the subsequent secured party – in the Deloitte case, Saskatchewan Court of Appeal, 1987 (hereinafter, the “Deloitte Case”).  In that case, Bank “A” acquired a general security agreement from the debtor and registered it in the Saskatchewan Personal Property Registry.  At the outset, the debtor did not own any serial numbered goods, but subsequently acquired some which became subject to a security interest in favour of Bank “B” which Bank “B” did properly register against the serial numbered goods.  Even though Bank “A” had taken and registered its security interest before Bank “B” took and registered its security interest, the Court held that Bank “A”’s security interest in the serial numbered goods was not perfected and that Bank “B”’s security interest in them was perfected.  In the circumstances, failure to register against the after-acquired serial numbered goods amounted to a failure to perfect Bank “A”’s security interest, as required by the Act and its regulations.

Although the judgment in the Deloitte Case does not say so, a likely reason why Bank “A” failed to amend its original registration to include proper serial numbered goods particulars was because Bank A was simply unaware of the fact that the debtor had acquired the serial numbered goods.  This is a dilemma for creditors who wish to acquire security in all of the debtor’s present and after-acquired personal property – i.e., that at a later point in time, the debtor may acquire serial numbered goods that the creditor isn’t even aware of, and thus fails to properly perfect against such goods, with the result that the creditor loses priority to a subsequent creditor of the debtor (who does properly register against the serial numbered goods), or to the debtor’s bankruptcy trustee.

Where the subsequent secured party properly registers against subsequently acquired serial numbered goods and that secured party finances the debtor’s acquisition of the goods (i.e. acquires a “purchase money security interest” in the goods), the result is arguably fair.  But where the subsequent secured party does not so finance, the result is arguably unfair.

Absent a change in the legislation (to somehow exempt the original secured party from the need to amend its registration to cover subsequently acquired serial numbered goods where the original secured party has no knowledge of the acquisition of such goods by the debtor), and, subject to what I say in the next succeeding paragraph hereof,  the only suggestion that this writer can make is for the original secured party to vigilantly monitor its debtor’s business activities and acquisitions on an ongoing basis.

There is another possible argument that the secured party might make to give it priority over a subsequent secured party, where the original secured party does not register against after-acquired serial numbered goods, but the later secured party does so.  This argument would only work where the original secured party is able to establish that the debtor's subsequently acquired serial numbered goods were proceeds of the original collateral subject to the earlier secured party's security interest.  The argument would be based on the priority given to a secured party's security interest in proceeds which are derived from original collateral which was subject to the secured party's security interest, Sections 28(1) and 28(2) of the Personal Property Security Act.  The argument also hinges on the way in which the PPSA deals with non-perfected security interests in serial numbered goods, namely:

(i)            Section 43(8) dealing with consumer serial numbered goods provides that failure to duly register against serial numbers means that the secured party's registration is ”invalid"; and

(ii)           Section 35(4) which deals with a secured party's failure to duly register against serial numbers where the collateral is business equipment, does not say "invalid", but instead provides that the security interest is not registered or perfected by registration for the purposes of Sections 35(1), 35(7), 35(8) and 34(2), the point being that none of these Sections refers to or includes aforementioned Section 28.