Secured Transactions – Winter 2013 Professor: Yael Emerich Summary
Scope of PPSAs: What is a Secured Transaction?
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- Deemed Security Interests
- (i) Assignment of Accounts
- (ii) Assignment of Chattel Paper
- (iii) Leases Longer than One Year
- (iv) Commercial Consignments
Scope of PPSAs: What is a Secured Transaction?GeneralAll Canadian PPSAs contain a functional definition of security interests: a security interest is created whenever the parties to a contract create (e.g. a lien, a charge, or a trust interest), retain (title retention or conditional sale), transfer (chattel mortgage, security assignment), or otherwise manipulate an interest in personal property in order to secure the performance of an obligation. The exact legal form of their transaction is unimportant. What matters is the effect. In addition to the functionalist definition, all PPSAs include certain deemed security interests in the definition, such as leases over one year (both acts), transfers of accounts and chattel paper (both), and some other transactions like consignments (NBPPSA only). Certain transactions are excluded from the security interest concept under both acts (see section 2.2.4 below). Walsh Text 2005 [83+] [83, 197] “The concept of consensual security interest adopted by the Act is intended to be exhaustive. A transaction will give rise to a security interest within the meaning of the Act if the following four requirements are satisfied: (1) The transaction creates or evidences a proprietary interest in an asset in favour of a creditor; (2) The asset is personal property. (3) The creditor’s proprietary interest functions to secure payment or performance of an obligation (4) The interest arises out of an agreement between the parties.” [84] “In the context of the PPSA itself, there is no need to determine the nature of a security interest other than to recognize that it is an interest that gives to the secured party the rights against specific kinds of competing claimants and against the debtor that are set out in the Act. However it is relevant in other contexts to identify the central concept of the PPSA. … [W]hen the rights of a secured party or debtor come into conflict with those of a third-party claimant in a context not regulated by the PPSA, it may be necessary to determine the nature of a security interest in order to determine the outcome of the conflict.” [84] [ex: someone vandalized a car being rented for a three year period; who can sue from trespass to chattels, the lesee or the lessor? This kind of tort issue isn’t covered by the PPSAs - Mike] [85] The security interest is analogous to a roman law hypothec or an equitable charge. It is an encumbrance on property belonging at least in part to the debtor. A security interest is clearly independent of title to the property; either the creditor or the debtor or someone else can have legal ownership of the property (NBPPSA 3(1); OPPSA 2(a)). The security interest is also free from the common law maxim of nemo dat quod non habet (i.e. that no one can give what they do not have), since the PPSA priority system determines the rights of parties. The security interest can be either possessory or non-possessory. [180] Although the PPSA can apply to debts, bonds, and other intangible obligations to pay, almost all land-related rights fall outside the PPSAs. This was a legislative choice, since it was felt that most people interested in ownership of a mortgage would check the land registry for second mortgages, rather than the PPSA to see if someone had taken out a security interest on the mortgage. As a result, competing interests related to land are normally determined by land law. Ontario did things a little differently though: “The Ontario Act permits a secured party with a PPSA interest in a right to payment under a lease, mortgage or charge of real property to register a notice of the interest in the personal property security registry and in the land registry for the district in which the relevant parcel of land is located (OPPSE 54(1)(b)). If only PPSA interests are in conflict, PPSA law governs. If the conflict is between a security interest in the right to receive money and an interest in the land itself, whoever registers first against the land. OPPSA Definition of Security Interest “security interest” means an interest in personal property that secures payment or performance of an obligation, and includes, whether or not the interest secures payment or performance of an obligation, (a) the interest of a transferee of an account or chattel paper, and (b) the interest of a lessor of goods under a lease for a term of more than one year; NBPPSA Definition of Security Interest “security interest” means (a) an interest in personal property that secures payment or performance of an obligation, but does not include the interest of a seller who has shipped goods to a buyer under a negotiable bill of lading or its equivalent to the order of the seller or to the order of an agent of the seller, unless the parties have otherwise evidenced an intention to create or provide for a security interest in the goods, and (b) the interest of (i) a consignor who delivers goods to a consignee under a commercial consignment, (ii) a lessor under a lease for a term of more than one year, (iii) a transferee under a transfer of an account or a transfer of chattel paper, and (iv) a buyer under a sale of goods without a change of possession, that does not secure payment or performance of an obligation;
Special CasesAs the authors of the Walsh text point out, the following transactions are included because the PPSAs are basically functional regimes, and the transactions below achieve the same outcomes as traditional common law security contracts. In all cases a creditor retains title to an item, and while the debtor is in possession of the item, it does not fully belong to the debtor. Thus third parties relying on the debtor’s apparent ownership of the item when advancing credit could be deceived. Similarly, the creditor could be prejudiced by a seizure of the debtor’s apparent assets carried out by another creditor. In general, the various deemed security interests are subject to the PPSAs for perfection and priority purposes, but are excluded from its enforcement provisions, because the “debtor” of the deemed security agreement does not have a proprietary interest in the collateral that needs protection from overly aggressive creditors [Walsh text; 83]. i) Conditional Sales [87+]Walsh text [87] points out that the condition sale is not a kind of transaction that really fits with the hypothecation concept of the security interest. With a conditional sale there is no interest for the debtor to grant to the creditor, since the debtor has no interest in the property beyond possessory rights which are inferior to the creditors’ rights. So conditional sales contracts (also known as title retention agreements). However, there is abundant case law concluding that conditional sales are covered by the PPSAs. They are subject to all PPSA provisions, including perfection, priority, and enforcement. ii) Leases and Financing Leases [88+]Leases with a duration of more than one year are deemed to create security interests by both PPSAs. Leases with a shorter duration may also be security interests, if they have the effect of creating a security interest. In both cases the perfection and priority regime will apply to the lease. However, the enforcement parts of the PPSA will not apply to deemed leases (OPPSA 57.1; NBPPSA 55(1)(a)). So the characterization of a lease is important both for leases shorter than one year, or to determine whether the enforcement provisions apply to leases that are longer than one year. Answering this question requires the judge to decide whether the lease in question is a “true lease” or a “financing lease.” This is a question of substance: is the lease closer to a conditional sale or other financing mechanism than it is to a regular lease? In general, if the lessee are equivalent to those of a buyer of a good, the transaction will be treated as creating a financing lease. Factors pointing towards a security lease include: (1) automatic vesting of ownership or a very cheap option to purchase at the end of the lease, or if the contract obliges the lessee to buy the property, it will be a financing lease regardless of other factors; (2) does the lease last for substantially all of the item’s useful life? If yes, this points to a financing lease; (3) If the cost to the lessee is equivalent or greater than the capital cost of the item, this suggests a financing lease; (4) If the lease has an option to renew, is the price of the option and the length of the option such that it is below the market rate for sale/rental of the item? If yes, this suggests the lessor has already recovered most of the value of the transaction from the rental payments, which means factor (3) above is satisfied, which points towards a financing lease; (5) An “open-ended lease,” which is a special kind of lease, not an indefinite lease, points to a security transaction [92-93]; (6) The role of the lessor can be a strong indicator, if the lessor does not behave like a regular rental business (example, lessor buys property lessee wants, then rents it out, rather than holding an inventory of goods for rent); (7) Contractual remedies that give the lessor remedies inconsistent with a normal lease (like an acceleration clause) point towards a financing transaction. Under both the OPPSA and the NBPPSA, the lessor of goods for more than one year has a “purchase money security interest,” (PMSI) with the exception of a sale and lease back transaction. This is important because a PMSI is the strongest form of security interest, and if registered correctly, will outrank all other PPSA security interests, regardless of when they were perfected. OPPSA Definition of a Lease “lease for a term of more than one year” includes, (a) a lease for an indefinite term, even if the lease is determinable by one of the parties or by agreement of two or more of the parties within one year from the date of its execution, (b) a lease for a term of one year or less if the lessee, with the consent of the lessor, retains uninterrupted or substantially uninterrupted possession of the leased goods for a continuous period of more than one year, but a lease described in this clause is not a lease for a term of more than one year during the period before the day the lessee’s possession of the leased goods exceeds one year, (c) a lease for a term of one year or less if, (i) the lease provides that it is renewable for one or more terms at the option of one of the parties or by agreement of all of the parties, and (ii) it is possible for the total of the original term and the renewed terms to exceed one year, but does not include, (d) a lease by a lessor who is not regularly engaged in the business of leasing goods, or (e) a lease of household furnishings or appliances as part of a lease of land, if the use and enjoyment of the household furnishings or appliances is incidental to the use and enjoyment of the land; NBPPSA Lease Provisions The NBPPSA definition of leases is the same as the OPPSA, with one additional “does not include” clause: “(f) a lease of goods of a prescribed kind, regardless of the length of the term of the lease.” There do not seem to have been any such regulations passed. The NBPPSA also states that a debtor acquires possession of leased goods when they are transferred to the debtor under the terms of the lease (NBPPSA 12(3)). 21 If a lessor for more than one year loses a priority contest with someone claiming the collateral under 20(a) or 20(b), and if the collateral is seized pursuant to the execution of a judgment against by someone with priority over the lessor under 20(1), the lessor has an action in damages against the lessee equal to (a) the value of the leased goods at the time of the bankruptcy, winding-up order or seizure, and (b) the amount of any loss beyond that stated in (a) that resulted from termination of the lease
iii) Consignments and Security Consignments [92+]In Ontario, a security consignment will be subject to all PPSA provisions (perfection, priority, and enforcement), while a regular consignment will not (OPPSA 2(a)(ii)). In New Brunswick, only commercial consignments and security consignments are subject to the PPSA [93]. A commercial consignment is subject to the perfection and priority provisions, but not the enforcement ones (NBPPSA 3(2)(a); 55(1)(a)). A security consignment is subject to all aspects of the act (NBPPSA 3(1)(b)). A debtor acquires possession of consigned goods when they are transferred to the debtor under the terms of the consignment (NBPPSA 12(3)). Under both the OPPSA and NBPPSA, the consignor has a purchase money security interest. Again, this is important because purchase money security interests are superior to all other perfected PPSA security interests, even those perfected before the PMSI. It is an accepted rule of evidence that the creditor must prove that the consignment is a true consignment, and not a security consignment [93]. In a true consignment, the merchant is the agent of the supplier, and sells goods belonging to the supplier on the supplier’s account. When the goods are sold, title passes directly from the supplier to the buyer. The merchant has no obligation to pay for the goods before they are purchased by the third party. The supplier has the right to demand the return of the goods at any time. The merchant has the right to return unsold goods to the supplier at any time. The merchant has to keep the supplier’s goods separate from his own. The goods are shown as an asset in the accounting records of the supplier, but not of the merchant. The merchant acknowledges the title of the supplier when dealing with others interested in the goods. Shipping documents refer to the documents as consigned goods, and any insurance on them is taken out by the supplier, not the merchant. By contrast, a security consignment will lack many of the above features. Additionally there is a determinative feature of a security consignment: the merchant has an obligation to purchase the consigned goods, or to pay a fixed fee regardless of whether the goods are sold or not [94]. The text suggests that if an agreement does not contain this kind of obligation, it cannot be a security consignment. NB PPSA Consignment Provisions 1 … “commercial consignment” means a consignment under which goods are delivered for sale, lease or other disposition to a consignee who, in the ordinary course of the consignee’s business, deals in goods of that description, by a consignor who, (a)in the ordinary course of the consignor’s business, deals in goods of that description, and (b)reserves an interest in the goods after they have been delivered, but does not include an agreement under which goods are delivered (c)to an auctioneer for sale, or (d)to a consignee for sale, lease or other disposition if the consignee is generally known to the creditors of the consignee to be selling or leasing goods of others; 21 If a commercial consignor loses a priority contest with someone claiming the collateral under 20(a) or 20(b), and if the collateral is seized pursuant to the execution of a judgment against by someone with priority over the consignor under 20(1), the consignor has an action in damages against the consignee equal to (a) the value of the leased or consigned goods at the time of the bankruptcy, winding-up order or seizure, and (b) the amount of any loss beyond that stated in (a) that resulted from termination of the consignment iv) Trusts and Security Trusts [95+]The New Brunswick PPSA specifically mentions trusts as potential sources of security interests (3(1)(b)). The Ontario PPSA only mentions “equipment trusts,” “trust receipts,” and “trust indentures” at (2(a)(i)), but the general definition of security interest in the 2(a) would catch security trusts. A trust will fall within the scope of the PPSA only if it is a security trust, that is, a trust that secures the performance of an obligation. The text provides several examples of security trusts [96] and non-security trusts [96-97]. The question which must be asked is whether the beneficiary’s interest in the trust has the effect of securing an obligation. This obligation must be external to the trust, because the beneficiary’s interest always secures the performance of equitable obligations internal to the trust itself by the trustee. Characterizing a trust as a security trust is a factual analysis that includes consideration of purpose of the transaction which created the trust; the role and relationship of the parties; practicality and commercial reality; and the intention of the parties with respect to the transactions which created the trust (Skybridge (Appeal)). There is some authority that Quistclose trusts are not security trusts (Gignac, Sutts; Carevest Capital), but I think these cases are wrongly decided. A Quistclose trust exists in order to restrict how debtors use loaned funds, and to protect those funds from bankruptcy. So it definitely seems like a trust that exists to secure the performance of an obligation, namely an obligation to spend trust money on an approved purpose and to repay the lender. Gignac, Sutts v National Bank of Canada, [1987] OJ no 298, 5 CBR (4th) 44 (SC). Re Skybridge Holidays Inc, [1998] BCJ no 1296, 13 PPSAC (2d) 387 (SC), aff’d 1999 BCCA 185. Carevest Capital Inc v 1262459 Alberta Ltd, 2011 CarswellAlta 391 (Master), rev’d 2012 ABCA 161 (the appeal decision arguably per incuriam, since Twinsectra does not seem to have been cited to the court). There is a judgment by the Ontario Court of Appeal which allowed a trustee to avoid the PPSA entirely (Re Berman). The decision has been treated as allowing trustees to elect between the PPSA regime and the law of trusts, but has been criticized and not followed in other provinces (McMahon). Re Berman, [1979] OJ 4407 (CA). McMahon v Canada Permanent Trust Co, [1979] BCJ 1951 (CA). Trust Indentures Security trusts should not be confused with “trust indentures” which are a completely different institution. Trust indentures are a way of holding bonds. One trustee is the legal owner of the bonds, and investors are beneficial owners. This allows the trustee to act for all bondholders. v) Floating ChargesFloating charges fall under the PPSAs because they are clearly security interests. Even though the traditional floating charge had to be “crystallized” before it could be asserted against third parties, modern courts have not treated the pre-crystallization floating charge as a voluntary delay of attachment [206; 225]. The modern PPSAs explicitly state that floating charges follow the same attachment rules as other security agreements (OPPSA 11(2); NBPPSA 12(1)). In general a floating charge carries an implied licence to sell property in the ordinary course of business, so buyers take free of the charge (Professor Smith lecture). Historically floating charges were often combined with fixed charges on existing property, giving creditors two levels of security. [206; Walsh Commentary] “An equitable security interest in the nature of a so-called ‘floating charge’ is classically described as hovering over the collateral without attaching to any specific asset until the charge is crystallized.” A floating charge is much like an open hypothec. It is a charge against all of a debtor’s current and future property, but whose effects are suspended until the charge is “crystallized” by the creditor. Once it crystallizes, the floating charge gives the right to seize and sell property, or to manage the business under a receiver. Issues of whether the debtor could sell inventory free of the floating charge were typically resolved in favour of innocent buyers. Wood, “The Floating Charge in Canada” (1989) [222]: Floating charges are being abandoned in the PPSA provinces, since lenders now use a “General Security Agreement” which grants a security interest in all of the debtor’s current and future property. This GSA will be much like a floating charge, but with far superior priority, since it ranks just like any other PPSA interest. Importantly, there is no such thing as a “floating security interest” - just fixed ones. This can make conceptualizing certain features of a floating charge difficult under the PPSAs [226]. For example, payment of wages by an employer who granted a floating charge/general security agreement will generate deemed trusts over amounts the employer is supposed to withhold and pay to the government, like EI and pension deductions. Do these deemed trusts have priority over the GSA/floating charge? The answer has typically been yes, and courts have reasoned that the GSA holder authorized payment of wages to employees, which must also authorize payroll deductions, so the deemed trusts are exempted from the GSA/floating charge. Hence there is no priority conflict. vi) Security AssignmentSecurity assignments look a lot like a mortgage. The debtor assigns property to the lender, who may keep it if the loan is not paid. Where the assignment property is a debt, the assignment can be with recourse (the debtor has to pay the debts go bad or otherwise can’t be collected) or without recourse (the debtor has not obligation to make up for bad debts). Deemed Security InterestsThe PPSAs apply to three types of transactions that are not functionally security interests, but which are deemed into the act: assignments (sales) of accounts; assignments (sales) of chattel paper, and leases longer than one year. The New Brunswick PPSA also applies to commercial consignments (see section 3.2.1(iii) above) and a sale of goods without change of possession. The deemed security transactions are subject to the attachment, priority, and perfection regimes, but not to the enforcement provisions (NB 55(1), OPPSA 57.1). They are enforced like any other common-law right. The policy reasons for including these transactions is that in each case the debtor is in apparent possession and control of property without actually owning it. So to allow creditors and third parties notice of these interests, it is necessary that they be registered. NBPPSA Deemed Security Interests 3(2) Subject to sections 4 and 55, this Act applies (a) to a commercial consignment, (b) to a lease for a term of more than one year, (c) to a transfer of an account or chattel paper, and (d) to a sale of goods without a change of possession, that do not secure payment or performance of an obligation.
2 Subject to subsection 4 (1), this Act applies to, … (b) a transfer of an account or chattel paper even though the transfer may not secure payment or performance of an obligation; and (c) a lease of goods under a lease for a term of more than one year even though the lease may not secure payment or performance of an obligation (i) Assignment of Accounts“account” means a monetary obligation not evidenced by chattel paper, a security or an instrument, whether or not the obligation has been earned by performance, but does not include investment property; The PPSAs basically create a mechanism which tracks ownership of obligations to pay. (ii) Assignment of Chattel PaperApparently the reason chattel papers were included was to create a clear legal regime for dealing with changes in ownership of chattel paper, because the law had previously been quite murky. I don’t think we need to know any more than that. Commercial practice is that transfer of the document counts as transfer of the interest in the chattel, so the PPSA reflects this, but imposes a security interest regime in order to publicize ownership of the chattel paper, since this can transfer independently of the chattels. (iii) Leases Longer than One YearThe OPPSA and NBPPSA provide identical, elaborate, definitions of leases longer than one year in the interests of clarity. “lease for a term of more than one year” includes (a) a lease of goods for an indefinite term including a lease for an indefinite term that is determinable by one or both parties within one year after its execution, (b) a lease of goods initially for a term of one year or less if the lessee, with the consent of the lessor, retains uninterrupted or substantially uninterrupted possession of the leased goods for more than one year after the lessee, with the consent of the lessor, first acquired possession of the goods, but the lease does not become a lease for a term of more than one year until the lessee’s possession extends beyond one year, and (c) a lease of goods for a term of one year or less where the lease provides that it is renewable for one or more terms automatically or at the option of one of the parties or by agreement of the parties if the total terms, including the original term, may exceed one year, but does not include (d) a lease of goods by a lessor who is not regularly engaged in the business of leasing goods, (e) a lease of household furnishings or appliances as part of a lease of land where the goods are incidental to the use and enjoyment of the land, or (f) a lease of goods of a prescribed kind, regardless of the length of the term of the lease; (iv) Commercial ConsignmentsThese are dealt with in section 3.2.2(iii), above. (v) Sales without Change of PossessionUnder the NBPPSA (but not OPPSA!) the buyer of personal property who does not go into possession of the property must register the sale as if he had acquired a security interest. Otherwise, his interest in the goods can be defeated by a subsequent purchaser who does register the sale, or a good faith purchaser who takes possession, or indeed any intervening creditor with rights superior to an unperfected secured party. Note the VERY large definition of “sale” which effectively means “any transfer of any kind not intended to secure performance of an obligation” 1 … “sale of goods without a change of possession” means a sale of goods that is not accompanied by an immediate delivery and an actual, apparent and continued change of possession of the goods sold, but does not include a sale of goods in the ordinary course of business of the seller, and for the purposes of this definition, “sale” includes an assignment, transfer, conveyance, declaration of trust or any other agreement or transaction, not intended to secure payment or performance of an obligation, by which an interest in goods is conferred; Excluded TransactionsVarious transactions are excluded from the statute. The most important are liens/charges/other interests (like deemed trusts) arising by operation of law or by other statutes, and the exclusion of land-related security interests. OPPSA Provisions 4. (1) Except as otherwise provided under this Act, this Act does not apply, (a) to a lien given by statute or rule of law, except as provided in subclause 20(1)(a)(i) or section 31; (b) to a deemed trust arising under any Act, except as provided in subsection 30 (7); (c) some, but not all, transfers or creation of rights under an insurance contract or a contract or annuity]; (d) to a transaction under the Pawnbrokers Act; (e) to the creation or assignment of an interest in real property, including a mortgage, charge or lease of real property, other than, (i) an interest in a fixture, or (ii) an assignment of a right to payment under a mortgage, charge or lease where the assignment does not convey or transfer the assignor’s interest in the real property; (f) assignment for the general benefit of creditors to which the Assignments and Preferences Act applies; (g) sale of accounts or chattel paper as part of a transaction to which the Bulk Sales Act applies; (h) assignment of accounts made solely to facilitate the collection of accounts for the assignor; or (i) assignment of an unearned right to payment under a contract to a transferee who will perform the transferor’s obligations.
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