January, 2011

Security interests, unlike diamonds, do not necessarily last forever or lose their lustre ("priority").  Two common situations in which a secured party can lose its security interest or the priority thereof are:

(i)            under Section 20 of the Manitoba Personal Property Security Act (the "MPPSA") - where a secured party fails to properly perfect its interest.  In this situation, the security interest doesn't entirely disappear, but it become unenforceable against most third party claimants, including the debtor's bankruptcy trustee; and

(ii)           Section 30(2) of the MPPSA - where the secured party holds a security interest in the debtor's inventory and the debtor sells items of its inventory to a buyer or buyers in the ordinary course of the debtor's business.  In this situation, the secured party's security interest is completely terminated insofar as the sold inventory is concerned, although the secured party is entitled to have its interest continue as against ("traceable") proceeds generated from the debtor's sale or sales (if there are any traceable proceeds).

The generally accepted rationale for the existence of Section 30(2) is that if "ordinary course" buyers couldn't purchase items of the debtor's inventory without having to search the registry to see if the debtor has given a security interest to its financier and then have to get the financier to release its security interest as against the particular item or items purchased, commerce would grind to a halt.

But what about a debtor who gives a security interest in its inventory to a financier, but who then leases - as opposed to selling - inventory items to one or more lessees?  Section 30(2) of the MPPSA provides that in this situation, the lessee "takes free of any perfected or unperfected security interest given by the lessor…whether or not the lessee knows of it (i.e., the security interest given to the lessor's financier) unless the lessee also knows that the lease constitutes a breach of the security agreement under which the security interest was created".  It would be rare indeed for an "ordinary course" lessee to know both of the existence of a security interest given to the lessor's financier and of the fact that the lease was contrary to the terms of the financier's security agreement with the lessor.

But what does Section 30(2) actually mean to the lessee and those claiming under and through the lessee, such as others to whom the lessee might attempt to sell or re-lease the goods, others to whom the lessee might attempt to mortgage the goods, and, the lessee's trustee in bankruptcy where the lessee becomes bankrupt?  Three cases form the 1990s and a B.C. case decided in November of 2010 give guidance to those involved in goods leasing transactions.  The most recent case is the Perimeter/Century/GE case (the “GE Case", British Columbia Court of Appeal).  The 1990s cases were reviewed by the Court in the GE Case. Before considering the facts and reasoning in the GE Case, it is instructive to consider the Court’s analysis of the aforementioned three previous cases. The following is a summary of these cases:

1. The Car-Ant Investments Ltd. case, Saskatchewan Court of Queen's Bench, 1990 (the "Car-Ant Case").  "D" acquired ownership of some trailers and then leased them to "B", the lease including options to purchase.  "D" failed to properly register its lease interest in the Personal Property Registry.  Subsequently, "D" granted a security interest in the trailers (and the leases) to GMAC.  GMAC did duly register its security interest in the Personal Property Registry, against both the trailers and the leases.  Subsequently, "B" became bankrupt.  The Court noted that "D" was in the finance business, not the business of dealing in trailers.  "B's" bankruptcy trustee argued that in order for GMAC to have priority over the trustee with respect to the trailers, GMAC not only had to duly register against the trailers, but that it also should have ensured that "D" had duly registered its lease interest against the trailers.  The Court disagreed, stating that it was not necessary for a financier in GMAC's position to have to ensure "double" perfection against the leased goods.  The Court also held that GMAC's right to proceed against the trailers arose immediately, and that it was not necessary for GMAC to honour the lease.  This was because "D" was not leasing the trailers to "B" in "D's" ordinary course of business, with the result that the Saskatchewan equivalent of the above-quoted rule (i.e., the Saskatchewan equivalent to Section 30(2)) did not apply.
2. The David Morris Fine Cars Ltd. case, Alberta Court of Queen's Bench, 1994 (the "Morris Case").  "M", being in the business of leasing and selling vehicles, leased a vehicle to "B".  "M" failed to register its lease interest in the Personal Property Registry.  Subsequently, "M" mortgaged its interest in the vehicle (and the lease) to BMO.  BMO duly registered its interest against the vehicle (and the lease) in the Personal Property Registry.  Subsequently, "B" became bankrupt.  A contest arose over who was entitled to the vehicle (or the proceeds of sale thereof), "B's" bankruptcy trustee or BMO.  The trustee argued that because BMO had taken its security interest in the vehicle after "M" had leased it to "B", BMO took its security subject to the "weakness" in "M's" legal position (i.e., "M's" failure to register notice of its lease rights in the vehicle in the Personal Property Registry), so that BMO's position was subordinate to the trustee's position.  Although not stated explicitly, there is a suggestion here that had "M" first granted security in the vehicle to BMO, with BMO duly registering its interest in the Personal Property Registry, a subsequent leasing of the vehicle to "B" might have given BMO priority over "B’s” bankruptcy trustee notwithstanding the failure by "M" to register its lease interest in the Personal Property Registry.  The Court also appears to have taken the view that with "M" having leased the vehicle to "B" in the ordinary course of the carrying on of "M's" business, unlike the situation in the Car-Ant Case, the Alberta equivalent of Manitoba Section 30(2) applied and, contrary to what was held in the Car-Ant Case, the affect of the legislation was to exterminate BMO's security interest.  As it turned out, BMO appealed the trial Court's decision, but for whatever reason, that appeal was never heard.
3. The Re Giffen case, Supreme Court of Canada, 1998 (the "Giffen Case").  Here TLC, which was in the business of leasing and dealing in motor vehicles, leased a vehicle to "T".  Thereafter, "T" subleased the vehicle to "B".  Neither of TLC or "T" duly registered their lease and sublease interests in the Personal Property Registry.  Subsequently, "B" became bankrupt, and a contest arose between "B’s” bankruptcy trustee and TLC as to who was entitled to priority in the vehicle (or the sale proceeds thereof).  The Court noted that while TLC was in the business of leasing vehicles, "T" was not.  The contest was between the bankruptcy trustee and TLC (not “T”) as to who had priority over the vehicle or the proceeds of sale thereof.  The trustee argued that the effect of the British Columbia equivalent to Manitoba Section 20(b)(i) was to subordinate (or extinguish) TLC's rights in the vehicle in favour of the trustee's rights.  On an initial appeal, TLC argued that on the basis of Section 71(2) of the Canada Bankruptcy and Insolvency Act (the "BIA"), the bankruptcy trustee only succeeded to whatever were the property rights of the bankrupt on bankruptcy and that at the time of its bankruptcy, "B" was merely a lessee and not an owner of the vehicle.  This appeal initially succeeded, but the Supreme Court of Canada disagreed. It held that in considering the application of the Personal Property Security Act to this situation, it is not appropriate to focus on such concepts as proprietary rights, title and ownership.  Personal Property Security legislation ignores the concepts of title and ownership, and instead, focuses on the priority of competing rights and interests, and that is the correct way to resolve these disputes.  Thus "B’s” trustee was entitled to enforce its rights under the BIA (for the benefit of "B’s” creditors generally) in priority to the rights of either TLC or ("T") because neither of TLC or "T" had properly perfected their lease and sublease interests in the PPR.  In effect, the trustee could and did get a better "title" to the vehicle than TLC and "T".

In the GE Case, “L”, being the owner of three buses, leased those buses to “B” but “L” failed to properly register its lease interest in the British Columbia PPR. Subsequently, “L” granted a security interest in the buses and in its rights under the leases to GE.  GE did properly register its security interest against the buses as well as against “L’s” rights under the leases. Subsequently, “B” became bankrupt and a contest arose between “B’s” bankruptcy trustee and GE as to who had priority with respect to the buses and/or the proceeds of sale thereof. The Court noted that in leasing the buses to “B”, “L” was doing so in the course of the ordinary carrying on of “L’s” business. Taking into account the reasoning in the aforementioned cases (the Car-Ant Case and the Giffen Case in particular) and the British Columbia equivalent of the above cited PPR rules, the Court held in favour of GE. The Court emphasized that when someone like “L” leases goods in the ordinary course of its business, the effect of the legislation is that a security interest in the goods granted by the lessor to its financier, will, as between the financier and the lessee, becomes “abridged”, but that that security interest will "spring back to life" (and thus enable the financier to realize its security) upon termination of the lease. The lessee does not acquire ownership of the goods, but instead can assert its lease rights (essentially possession of the leased goods) in priority to the financier’s security rights but only until the lease ends. In the GE Case, “B’s” trustee did not make any of the rental payments due under the leases, the buses were returned to “L”/GE and consequently, the leases were at an end.

What does the GE Case and the earlier cases considered by the Court in the GE Case suggest for those in the leasing business and those financing such business? I suggest the following:

(i)            the need for lessors and their secured creditors to make proper registrations in the Personal Property Registry;

(ii)           a lessor’s financier does not - for its own sake alone - have to ensure that the lessor properly registers its lease interest as long as the financier has properly registered its security interest (although, for their own benefit, lessors should duly register their lease interests); and

(iii)          where a lessor has leased goods to a lessee in the ordinary course of the lessor’s business, and, prior or subsequent to such leasing, the lessor grants a security interest in the goods to the lessor’s financier, the financier’s security interest is not capable of being enforced by the financier as against the lessee’s possessory rights under its lease unless and until the lease ends.