November 2010

THE SOMETIMES CONFUSING INTERPLAY BETWEEN SECURITY TAKEN UNDER

THE BANK ACT (CANADA), SECTION 427, AND, SECURITY TAKEN UNDER A PROVINCIALLY GOVERNED PERSONAL PROPERTY SECURITY ACT

Two recently released judgments by The Supreme Court of Canada, Innovation Credit Union (November 5, 2010, hereinafter, the “Innovation Case”), and, Radius Credit Union (also November 5, 2010, hereinafter, the “Radius Case”), both of these decisions upholding the previous decisions of The Saskatchewan Court of Appeal, highlight and analyze the dilemma referred to in the title to this paper.  The problem arises where one creditor takes security on collateral under Section 427 of the Bank Act (Canada) (only banks chartered under that Act can acquire this type of security) and, another creditor takes security on the same collateral under one of the common-law provinces’ Personal Property Security Acts (“PPSA”, any creditor can take this type of security).  In both the Innovation Case and the Radius Case, a bank and a credit union each took security on the same collateral, the credit union taking its security under the Saskatchewan PPSA and the bank taking its security under Section 427 of the Bank Act.  In both cases, the question to be determined was which of the credit union and the bank had priority with respect to the commonly secured collateral. 

The facts in the Innovation Case were:

(i)            first the debtor acquired the collateral;

(ii)           next, the debtor gave a PPSA governed security interest in the collateral to the credit union with, the credit union not filing (“perfecting”) its security interest in the Personal Property Registry;

(iii)          next, the debtor gave security in the same collateral to the bank under Section 427 of the Bank Act, with the bank:

(a)           duly registering notice of its taking of its security under Section 427; and

(b)           having no notice of the existence of the credit union’s earlier acquired security interest (the debtor, whether intentionally or negligently, failed to advise the bank that it had previously given security to the credit union), and, although the bank searched the debtor’s name in the Personal Property Registry, with the credit union having failed to file notice of its security therein, that search by the bank revealed nothing about the credit union’s security.

The facts in the Radius Case were:

(i)            first, the debtor gave a PPSA governed security interest in the debtor’s present and after-acquired personal property to the credit union, with the credit union not filing (“perfecting”) its security interest in the Personal Property Registry;

(ii)           next, debtor gave a security interest in (part of) its present and after-acquired personal property to the bank, with the bank:

(a)           duly registering notice of its taking of its security under Section 427 of the Bank Act; and

(b)           having no notice of the existence of the credit union’s prior security agreement (again, the debtor, whether intentionally or negligently, failed to advise the bank that it had previously granted security to the credit union), and, (again), with any search by the bank of the debtor’s name in the Personal Property Registry, the bank would not and could not have obtained notice of the credit union’s security because the credit union failed to register; and

(iii)          next, the debtor acquired collateral which became subject to both the credit union’s security and to the bank’s security (in the Court’s view, the credit union’s security and the bank’s security attached to the collateral simultaneously).

The only difference between the fact scenario in the Innovation Case and that in the Radius Case was that in the Radius Case, the debtor did not acquire the affected collateral until after it had entered into its security arrangements with (both of) the credit union and the bank.

Needless to say, the primary question in each case was which of the competing secured creditors had priority with respect to the affected collateral, the bank or the credit union?  The Saskatchewan Court of Appeal held for both of the credit unions, and The Supreme Court of Canada agreed with the Court of Appeal’s decisions.

Essentially, and in both cases, the Court held that:

(1)          In a dispute involving PPSA governed security and Bank Act, Section 427 security, you can’t look to the provincial legislation for a rule or an answer to determine this type of priority dispute;

(2)          When you analyze the Bank Act, while it is true that legislation does have some priority rules which would determine the outcome of priority disputes in some cases involving PPSA governed security and Bank Act, Section 427 security, the Bank Act itself does not have – at least in its present format – a rule which can be used to determine who has priority in these particular two cases;

(3)          The Bank Act requires one to examine the applicable provincial rules dealing with property rights and interests in order to determine what rights and interests the debtor had in the collateral at the times when it provided security to each of the credit union, and in particular, to the bank; and

(4)          UtilizingSaskatchewanproperty rights and interests laws – essentially common law rules and concepts:

(a)           In the Innovation Case, after the debtor had granted the credit union its security interest, the only rights and interests it retained in the collateral – which were then available to be granted to the bank – was the debtor’s equity of redemption (essentially, the debtor had nothing further available in the collateral to give to the bank, and the failure of the credit union to register its security interest didn’t and couldn’t change this); and

(b)           in the Radius case, although the debtor did not have any rights and interests in the subsequently-acquired collateral at the time that the debtor granted a security interest in such collateral to the credit union, the credit union nevertheless obtained what amounted to an “inchoate” right in the after-acquired collateral, as did the bank later on, but the credit union "wins" because it acquired its inchoate right prior in time to when the bank acquired its inchoate right. 

What do the Innovation Case and the Radius Case suggest for lenders and their counsel?  The writer suggests:

(i)            Parliament should amend the Bank Act, either to eliminate the security mechanism provided for in Section 427 completely, or, to provide that security interests taken under other personal property security regimes (such as the PPSAs) which are not duly registered in accordance with the requirements of such regimes will be subordinate to subsequently granted Bank Act security; or

(ii)           Whenever a bank takes Bank Act governed security, it should also take PPSA governed security and should perfect (ie, give public notice of) both of its securities under the respective federal and provincial legislation.  For banks wishing to take personal property security on assets situated inSaskatchewan,Saskatchewan counsel should be consulted due to the "peculiarities" of the Saskatchewan PPSA in its relationship with Bank Act governed security.