Jason Bryk 

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April 2014

The recent (Judgment given September 18, 2013) Supreme Court of British Columbia case CFI Trust v. Royal Bank of Canada (the "CFI Case") deals with a scenario which is probably more common in the business world than it should be.  The CFI Case dealt with a number of inter-related issues, each of which should be of interest to business people, financial institutions and their counsel.

1.         The Facts

CFI financed Totem Ford's acquisition of its inventory of motor vehicles and took a security interest in all of Totem's inventory and their proceeds.  The Bank also financed Totem's acquisition of its inventory of motor vehicles and additionally provided other financing, and took security over all of Totem's inventory and the proceeds thereof.  Totem disposed of its inventory by either selling vehicles or by leasing them, thereby generating profits for itself and - as was originally intended - funds to be used to repay Totem's indebtedness owed to CFI and the Bank.

Totem's arrangements with:

(a)          CFI, required Totem to pay all or substantial portions of the proceeds of its disposition of CFI financed vehicles to CFI; and

(b)          the Bank, required (similarly) the proceeds of disposition of the Bank financed vehicles to be paid to the Bank.

As part of its banking arrangement with the Bank, Totem established one or more deposit accounts and was required to pay all of its incoming funds into the Bank as a depository.  The Bank's financing arrangement with Totem additionally authorized and permitted the Bank to debit Totem's deposit account with the monies from time to time owed by Totem to the Bank.

Totem failed to pay disposition proceeds to CFI, and instead, those proceeds were placed in its deposit account with the Bank, with the Bank then applying those funds (as well as other funds placed in the deposit account) on account of the Bank indebtedness.  CFI answered the question that forms the title to this paper by responding that its monies ended up in the Bank's hands and then were then unfairly used by the Bank to improve its position (pay off Totem's debt to the Bank).  The CFI Case was the result of CFI's claim for reimbursement from the Bank.

It is of considerable significance in this case that the Court observed and held that:

(i)            CFI became aware of suspicious and probably fraudulent activity on the part of Totem long before the Bank became aware of same, and, CFI did not effectively challenge Totem with respect to tis conduct until long after CFI's suspicions were - or should have been - alerted;

(ii)           the amount claimed by CFI from the Bank represented a very small portion (0.6%) of all of the money which flowed into and out of Totem's deposit account with the Bank.

2.         Issue - Interpretation of the Intercreditor Agreement

CFI and the Bank entered into an intercreditor agreement which carved out each of the secured parties' respective areas of priority over Totem's assets.  The Bank was given priority over all of Totem's assets (present and future) except for CFI financed vehicles subject to leases or other sale contracts between Totem and its customers.  However, this exclusion did not extend to the proceeds (of disposition) of such vehicles.  Accordingly, the Court held that the Bank had priority over CFI with respect to proceeds, with CFI having priority over only the vehicles themselves.

Alternatively, CFI asked the Court to hold that a term be implied into the intercreditor agreement which would give CFI priority with respect to disposition proceeds.  The Court noted that there is a presumption against adding an unexpressed term to a contract by implication, unless, among other things, "it is necessary to do so in order to give the contract business efficacy (this does not include a test of reasonableness for the contract)".  The Court held that the intercreditor agreement was not ambiguous, and that it was not necessary to add an implied term to give CFI priority over proceeds in order to provide "business efficacy to the contract".  The way the intercreditor agreement was worded was advantageous to the Bank and disadvantageous to CFI, but this was not enough reason to add the CFI requested implied term.  Presumably, CFI and the Bank had - or at least had the opportunity to have - counsel review and finalize the appropriate wording.

Interestingly enough, the Court held that its interpretation of the intercreditor agreement was of itself sufficient to defeat CFI's claim, but nevertheless went on to consider and provide very useful guidance on a number of another issues raised by the parties.

3.         Issue - Restoration of CFI's Pre-Discharge PPR registration priority

During the course of CFI's dealings with Totem, CFI's Personal Property Security Act financing statement registration was inadvertently discharged.  Section 35(7) of the BC Act (the identical provision appears under the same section number in the Manitoba Act) would have allowed CFI to regain its original registration priority over the Bank, but only if CFI had discovered the inadvertent discharge and re-registered no later than 30 days following the date of the inadvertent discharge.  CFI did not discover the discharge until long after the expiration of such 30 day period.

CFI raised two arguments for the Court to restore its original registration priority over the Bank, notwithstanding the "drop dead" time period specified in Section 35(7) of the Act, namely:

(a)          that the Court should make an order under Section 63(2)(e) of the BC Act (substantially similar to Section 63(2)(e) of the Manitoba Act) bringing back CFI's priority on the basis that such order would be "necessary to ensure the protection of the interest of (a) person (here CFI) in the collateral".  The Court concluded that the meaning of the wording in Section 63(2)(e) was such that it did not justify issuance of an order "rejigging" the priorities between CFI and the Bank.  That was not what this Section was intended for.  It is interesting to note that in the Manitoba version of Section 63(2)(e) the words "any person in" do not appear.  This would suggest, at least in Manitoba, that it would be even less likely to convince a Court that this Section should be used to alter the priorities otherwise established by the rules in the Act.

(b)          that the Court should issue an order based on a combination of Section 68 of the BC Act (substantially the same as Section 65(2) of the Manitoba Act) and Section 70 of the BC Act (substantially the same as Section 66(1)(a) of the Manitoba Act) to reinstate CFI's registration priority over the Bank.  Section 68 of the BC Act provides that the "principles of the common law, equity and the law merchant, except insofar as they are inconsistent with the provisions of this Act, supplement this Act and continue to apply".  Section 70(a) of the BC Act provides that on the application of an interested person, a Court may "make an order determining questions of priority or entitlement to collateral".  Here, the Court agreed with CFI's submission and held that CFI's priority vis-a-vis the Bank should be restored.  The Court's reasoning appears to be based on its conclusions that:

(i)            Section 35(7) does not "address the consequences of failing to re-register within 30 days"; and

(ii)           Section 70(a) does not "include any language indicating that the discretion afforded to the courts to make                   orders determining priority is always subject to the other priority provisions (of the Act)".

It is this writer's respectful opinion that in so holding, the Court may have been implying an intention to the Legislature which didn't really exist.  Nevertheless, this holding provides some possible relief for secured parties who suffer the inadvertent discharge (or lapse) of their security registrations and don't find out about the discharge or lapse until after the 30 day "drop dead" period.

Note however that in the CFI Case, there was no prejudice to the Bank by restoring CFI's registration priority, that is, that the Bank would only have been put back in its original position as a subordinate registrant to CFI.  Additionally, remember that the Court had already determined the outcome of the case based on its interpretation of the intercreditor agreement.

4.         Issue - Should the Bank hold Priority on the Basis of Section 31 of the PPSA?

Several arguments were made, namely:

(a)          Section 31(1) of the BC PPSA (substantially the same as Section 31(1) of the Manitoba PPSA) provides, among other things, that a "holder of money" has priority over a security interest in the money which has been perfected by registration provided that the holder is a "holder for value".  "Money" is defined, in effect, as currency of the realm (or of some other realm).  This is a narrow definition of "money", in that it does not include such things as bank deposits, debts owed by non-depository financial institutions, cheques and other types of payment instruments.  CFI argued that because cheques (presumably drawn on Totem's customer's accounts) payable to Totem were not "money" within the meaning of Section 31(1), the Bank could not claim the protection which would otherwise be provided for against CFI's security interest.  There is little commentary by the Court on this position, but one can only assume that the Court agreed with CFI that Section 31(1) did not protect the Bank.

(b)          Sections 31(3) and 31(5) of the BC PPSA (substantially, although not exactly the same as Sections 31(4) and 31(6) of the Manitoba PPSA) provide that the "purchaser of an instrument" has priority over a security interest in the instrument perfected by registration, if the purchaser "gave value" for the instrument, and, the purchaser acquired the instrument "without knowledge" that it was subject to a security interest, and, the purchaser took possession of the instrument. Knowledge which would "taint" the purchaser (and not give it the Section's protection) is not only knowledge of the existence of another party's security interest in the instrument, but also knowledge that the transaction whereby the purchaser acquires the instrument violates the terms of the other party's security agreement.  No one argued that the Bank had not taken possession of Totem's customers' cheques, but CFI did challenge the Bank with respect to the other elements of the Section 31 requirements for a purchaser of an instrument, namely:

(i)            CFI tried to argue that when a customer's cheque was deposited to Totem's account at a time when that account was not overdrawn, the Bank would not be providing "value" to Totem for its acquisition of the cheque.  CFI emphasized that the manner in which the Bank provided its services to Totem (a deposit or operating account and a loan account) meant that Totem could never overdraw on its deposit/operating account (unless it has somehow managed to exceed its borrowing limits and the Bank let this happen).  The Court rejected this reasoning, holding that "value" was given by a depository/lender whenever a cheque is deposited (and "cleared" under the payment system), with that "value" being either the depository/lender crediting the account with the amount of the cheque, or with the depository/lender using the funds to pay back the depositor's debt.

(ii)           CFI argued that the knowledge possessed by the Bank of CFI's business activities was sufficient to disqualify it from the Section 31 protection given to instrument purchasers.  As noted above, Section 31(5) of the BC Act (virtually identical to Section 31(6) of the Manitoba Act) provides that to lose the Section 31 protection given to purchasers of instruments, the depository/creditor must not only know of the existence of a security agreement whose security interest would extend to the instrument (and the funds thereby represented), but also must know that acquisition of the cheque by the Bank and in particular, application of the proceeds thereof to reduce Totem's indebtedness was in violation of the security/financing arrangements between Totem and CFI.  The Court held that, while the Bank had acquired some knowledge of CFI's questionable business activities, it did not have actual notice or knowledge that the cheques were being deposited to the Bank (and then used to pay off the Bank) was in violation of Totem's obligations owed to CFI.  Actual - not constructive - knowledge was needed, and the knowledge that the Bank did have did not rise to the level of knowledge that would disentitle the Bank to take the cheques and apply the proceeds on account of Bank debt.  The Court also emphasized the fact that the deposits made of CFI's claimed funds represented a very small fraction of the total monies which flowed into (and out of) Totem's account.

(c)          Sometimes when Totem's customers made payments to Totem, instead of writing cheques on their financial institutions' accounts, Totem and its customers would arrange for the direct electronic transfer of funds from the customers' accounts to Totem's account with the Bank.  CFI argued that funds represented by such electronic transfers were not only not "money" as aforementioned, but also were not "instruments" within the meaning of Section 31.  The Court agreed with this submission, although again, the outcome of the case had already been decided on the basis of the wording in the intercreditor agreement.  Nevertheless, this finding may prompt the British Columbia Legislature to consider amending Section 31 so that electronically transferred funds can be treated (in the hands of the transferee) with the same protection given to purchasers of "instruments". Note however that in Manitoba, its Section 31(3) - dealing with "debtor initiated payments" - should be sufficiently broad in its application (it includes payments of funds made by an "electronic funds transfer initiated by the debtor") to overcome the fact that electronically transferred funds are neither "money", nor "instruments".  Manitoba Section 31(3)(c) deals specifically with funds received by a "deposit taking institution from a deposit account of the debtor held by the institution".  Nevertheless, there is a limitation specified at the very end of this Section which probably would not permit the deposit taking institution to be protected against a security interest in its debtor's deposit account money where the financing arrangement between the institution and the debtor simply permits the institution to take funds generally from the account to pay any and all debts.  Such an arrangement would be similar to a financial institution's right of set-off, but it would appear that it would not obtain the protection otherwise provided by Manitoba Section 31(3).

5.         Issue - Completely Aside from the Rules in Section 31 of the PPSA, did CFI have a Claim against the Bank on the (Common Law basis) of "Knowing Receipt" or "Unjust Enrichment"

(a)          "Knowing Receipt".  The Court pointed out that the Supreme Court of Canada held (in 1997) that in order to succeed in a claim of knowing receipt, the claimant must show that:

"(a)      the property in question was held in trust by a third party (here, Totem);

          (b)        the property was taken from the plaintiff (here, CFI) in breach of trust;

          (c)        the defendant (here, the Bank) received the trust property and applied it for its own use and benefit; and

          (d)        the defendant (here, the Bank) had either actual or constructive knowledge of the breach of trust".

          As noted in #4 above dealing with knowledge sufficient to "taint" someone who would otherwise be entitled to the protection afforded to a purchaser of an instrument by Section 31, the Court held that the Bank had very little actual knowledge of Totem's nefarious conduct.  Also, the Bank did not acquire sufficient knowledge or information that would "put it on notice" and thus oblige it to make further inquiries (ie, no or no sufficient constructive knowledge).  Depository financial institutions need to have it clearly brought home to them that a customer is paying funds to the institution in breach of a trust or other obligation owed by the depositing customer.  The Court emphasized that this state of affairs does not provide complete immunity to a depository financial institution, and the Court cited several earlier cases in which such institutions have had sufficient information brought to their attention that they should have ceased to do business with a customer and in particular, ceased to apply the customer's funds to debt owed to the institution.

(b)          Unjust Enrichment.  The Court noted that in order to succeed in a claim for unjust enrichment, the plaintiff must show:

"(i)        that it has been deprived;

(ii)        that the defendant has been enriched; and

(iii)       that there was no juristic reason for the enrichment.

Clearly, CFI had been deprived and the Bank had been enriched at the expense of CFI.  However, the Court agreed with the Bank's contention that there was a juristic reason for the enrichment, "namely the loan agreements between (the Bank) and Totem".

(c)          The Bank argued that with respect to both of CFI's claims for "knowing receipt" and for "unjust enrichment", the enactment of the Personal Property Security Act constituted a "complete code for secured transactions", so that there could be no such claims made against the Bank.  The Court chose not to deal with this position, but it will be interesting to see if anyone else raises a similar argument in a secured transaction dispute where a party is claiming reimbursement on the basis of either knowing receipt or unjust enrichment.  It is the writer's strong suspicion that a Court called upon to decide this issue would hold that there is still "room" for claims based on knowing receipt or unjust enrichment, notwithstanding the fairly broad coverage of the Personal Property Security Act to secured transactions.

6.         Lessons to be Learned

(a)          Issue #2 - CFI lost this case based primarily on the Court's interpretation of the wording of the intercreditor agreement.  More care should have been exercised by CFI's counsel before signing off on the agreement.

(b)          Issue #3 - there may be hope for a secured party whose registration has inadvertently lapsed or been inadvertently discharged, notwithstanding the "drop dead" time period specified in Section 35(7).  Counsel for a secured party finding itself in this position should consider the Act's Sections which would allow the secured party to be reinstated on an "equitable basis".

(c)          Issue #4 - there are two areas of concern here:

(i)            funds held and transferred electronically are not given Section 31 protection against secured parties in some jurisdictions (ie, British Columbia) and in others (ie, Manitoba), while they are given some protection, they are not given as broad a degree of protection as many financial institutions would like (and their customers might well be prepared to give them); and

(ii)           the relatively inadequate knowledge of CFI's nefarious business conduct held by the Bank and the relatively substantial knowledge of that conduct garnered by CFI, combined with the fact that the monies claimed by CFI represented a very small portion of the total monies flowing into and out of Totem's account with the Bank, make the CFI Case, at least in this regard, substantially "fact driven".  The facts may well be different in other similar cases.

(d)          Issue #5 - claims for reimbursement based on knowing receipt or unjust enrichment may be available to a secured party who is unable to establish the priority of its security interest against monies deposited into a financial institution.


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