February 2017

This paper has to do with a problem (the "Problem").

The Problem arises where a chartered bank (the "Bank") provides credit to an agricultural producer ("Producer") which is utilized, in whole or in part, to facilitate/effect the operation of the Producer's agricultural production business, in particular, the growing and production of crops ("Crops").  Typically, the Bank will take from the Producer to secure the obligations from time to time owed to the Bank by the Producer with respect to such credit, one or both of a security interest in the Producer's Crops governed by The Manitoba Personal Property Security Act (the "MPPSA") (usually in the form of a general security agreement, hereinafter a/the "GSA") plus a security assignment by the Producer to the Bank of the Producer's Crops pursuant to and as governed by Section 427 of the Bank Act (Canada) (hereinafter, the "Bank Act Security").

The Producer uses the value advanced by the Bank to produce the current year's crops, and (presumably) on an ongoing basis, the Bank advances further values year after year to the Producer on the ongoing security against each successive year's crops as created under the GSA and the Bank Act Security.

This paper assumes that the Bank will, in a timely manner, have made all registrations and taken all steps necessary to perfect it's security interests (under its GSA and under its Bank Act security) so as to achieve, at the earliest possible date, the highest possible priority.

The essence of the Problem arises when after the Bank has done all of the foregoing, someone else - typically an agricultural products support business ("Crops Inputter") - additionally provides inputs to assist the Producer to produce its Crops (on credit) and takes a security interest in those Crops.  Crops Inputters will usually provide such items as seed, fertilizer and pesticides.  The security taken by the Crops Inputter is governed by the MPPSA, the Crops Inputter being legally incapable of obtaining security under Section 427 of the Bank Act of Canada. 

Again, assume that the Crops Inputter has made registrations and done all that it can to achieve, as soon as possible, the highest possible priority for its security interest in the Crops.  Is it possible for the Crops Inputter, notwithstanding that it provides value to the producer and takes security after when the Bank has provided value and taken security in the same Crops from the same Producer, can obtain a retroactive priority over the Bank's security in the Crops?

If the Bank's provincially governed security interest could not "fit" within the classification of a "purchase money security interest" under the MPPSA and the Crops Inputter's provincially governed security interest could be so classified (and assuming that the Crops Inputter had done all that it needed to do under the MPPSA in order to achieve a retroactive purchase money security interest priority), then the Crops Inputter would indeed take priority in the Crops over the Bank, notwithstanding that the Bank had registered its provincially governed security interest before the Crops Inputter had registered its provincially governed security interest.  But is this really the case?

If the Bank's security interest could be classified as a "purchase money security interest" under the MPPSA, so that both the Bank's security interest and the Crops Inputter's (provincially governed) security interest would be classified as "purchase money security interests" under the MPPSA, then, depending on how the Crops Inputter advanced value, the Bank's security interest may - or may not - hold priority over the Crops Inputter's security interest.  If the Crops Inputter sold its inputs to the Producer on credit and took security therefor, then the Crops Inputter's security interest would hold its security over the prior the Bank security.  This is because the MPPSA says that where there are two purchase money security interests affecting the same collateral at the same time and one is "vendor credit" and the other is "lender credit", then - regardless of who has registered first - the holder of the security interest representing "vendor credit"  will win the priority contest.  On the other hand, if the Crops Inputter utilizes some subsidiary, affiliate or other financial institution to advance value to the Producer which the Producer then uses to buy inputs from the Crops Inputter, the Crops Inputter's (or more accurately, its subsidiary's affiliate's or connected financial institution's security interest) would - like the Bank - be a purchase money security interest securing "lender credit".  In that case, with the Bank having registered its "lender credit", purchase money security interest first, the Bank's security interest would hold priority over the Crop Inputter's (or its affiliate's) security interest.

But arguably, although the security interests held by each of the Bank and the Crops Inputter appear to be in the nature of purchase money security interests, in fact, they are NOT strictly speaking, "purchase money security interests", but rather a species of security interest which is sometimes colloquially called a "production value security interest" and which is dealt with specifically under Section 34(10) of the MPPSA.  In fact, the Bank's security interest under its GSA will most likely be in part a purchase money security interest, in part a production value security interest governed by Section 34(10) and in part, a security interest securing obligations which do not fall within the concepts of the values secured by purchase money security interests or production value security interests.

The answer to the above question is, in our opinion, "no".  This is essentially for two reasons:

1. As mentioned above, a "production value security interest" is not dealt with in exactly the same way as a "purchase money security interest" under the MPPSA.  Section 34(10) of the MPPSA provides:

"A perfected security interest in crops or their proceeds given for value to enable the debtor to produce the crops and given while the crops are growing crops or during a period of six months immediately before the time the crops become growing crops (and continuing thereafter, until the crops start growing), has priority over any other security interest in the same collateral given by the same debtor." (the underlining is the writer's, for emphasis purposes).

Where the Bank provides value that does in fact enable a Producer "to produce the crops" and the Bank does everything it is supposed to do to achieve priority as required by said Section 34(10), and, a Crops Inputter perfects (registered) after the Bank has registered, then, insofar as the Producer's Crops are concerned (although not necessarily with respect to other collateral covered by the Bank's GSA), priority should go to the Bank.  Note that Section 34(5) of the MPPSA - which, in effect, provides that a vendor credit security interest will take priority over a lender credit security interest, only applies to purchase money security interests, and (again, as stated above), the production value security interest dealt with in Section 34(10) of the MPPSA is not - strictly speaking - a purchase money security interest.  That means that priority, as between the Bank's security interest and the Crops Inputter's security interest must be determined by the MPPSA "residual rule" (Section 35(1)) which provides that the first to register wins a priority contest.  In this example, the Bank has registered first so it "wins".  Obviously, if the Crops Inputter had registered its production value security interest before the Bank had registered, then the Crops Inputter would "win".

There is one question which we still have to resolve.  That is, just how broad is the meaning of the words "to produce the crops" found in Section 34(10)?  Is it restricted to what a Crops Inputter normally provides, such as seed, pesticides and fertilizer, or, is it broader to also include costs paid for (with the Bank's loaned monies) relating to employing farm hands, electricity consumed, costs of servicing and operating farm equipment and machinery, and for that matter, all costs generally of the Producer's agricultural production business?  If "to produce the Crops" is in fact limited to provision of inputs (on credit) such as seed, fertilizer and pesticides, then there may be a need to apportion the use by the Producer of the credit extended by the Bank amongst what are clearly direct production inputs and other inputs (paid for with the Bank's credit) which are less directly connected with the creation of the Crops.

1. Where the Bank has acquired its Bank Act Security on the Producer's Crops and taken all steps required under the Bank Act to establish its priority, and, this occurs before the Crops Inputter perfects its security interests against the Crops, then the priority of the Bank's security in the Crops, as specified in Section 427 of the Bank Act, clearly gives the Bank priority over the provincially governed Crops Inputters security interest.  In this regard note:

(a)          Section 4(k) of the MPPSA provides that the MPPSA does not apply to a security arrangement governed by the Bank Act provided that the Bank Act "deals with the rights of parties to the (security) agreement or the rights of third parties affected by a security interest created by the agreement".  Clearly, Section 427 of the Bank Act (in particular, subsections (2)(d) and (4) so "deal with the rights of (the) parties…and…rights of third parties";

(b)          the Bank Act does not have any rules providing for two or more banks providing value to a Producer on the security of the same Crops, other than that if the Bank's Bank Act Security was competing with another Canadian chartered bank's Section 427 security on the same Crops, the bank which would "win" the priority contest between the two banks would be the bank that filed its Notice of Intention (to grant the Bank Act Security) first.

The foregoing considerations also raise the following issues and conclusions:

1. Where the Bank has taken its security and registered first before a Crops Inputter's MPPSA financing statement registration, the Bank should "win" the priority contest.
2. Where the Bank takes both a provincially governed GSA and a Bank Act Security assignment, the Bank's security would initially, under the GSA, extend to the seeds, fertilizer and pesticides which the Bank has financed the Producer's acquisition of (Section 427 (1)(d) of the Bank Act appears to limit the Bank's security to the Crops themselves), and thereafter, upon the seeds, fertilizer and pesticides being "put" into the soil, would also extend to the Crops commencing to grow therefrom, the Bank's GSA and its Bank Act Security would both extend to the Crops.  That does give a "window of opportunity" to the Crops Inputter, in that during the period of time that the Producer holds seed and/or fertilizer and/or pesticides (before the Producer puts those into the ground), the Crops Inputter's security interest - provided that the Crops Inputter is extending "vendor credit", not "lender credit" - would have priority over the Bank's GSA security interest in the same collateral.
3. Perhaps the best practical advice that can be given in this scenario of competing/overlapping secured creditors with respect to a producer's crops is for all concerned creditors (including chartered banks, Crops Inputters and any other parties advancing or considering advancing credit to an agricultural producer), to get together and work out a reasonable intercreditor agreement.  Such agreement would spell out the types of credit being provided by each creditor and define all creditors' respective priorities with respect to the Producer's crop inputs, crops and proceeds of those crops.