Possible Changes to the Canadian Personal Property Security Acts 2000

Section 2(1) – Definitions

( ) "account debtor" means a person who is obligated under an intangible or chattel paper.

COMMENT

This is not a new term or a new definition. It is currently contained in section 41(1). However, under the proposals which follow, the term is used in sections other than 41 (see proposed new s. 9(4) and proposed changes to s. 17(1) below). Consequently, it is suggested that the definition be moved to the general definition section.

( ) "authenticated" includes signed, or, where the writing to be authenticated is in the form of a data message, the use of a method which is as reliable as appropriate in the circumstances, including the purpose of the data message, to identify the authenticating person and to indicate that person’s approval of the information contained in the data message to which the authentication relates.

COMMENT

1. The Act currently requires that certain notices, demands, consents etc. be communicated and evidenced in writing: see e.g. sections 18(1)(1), 18(2), 43(12), 59(10)(d), 59(16)(f), 62(1)(a)-(b), 64(4) and 64(5). It is implicit in these sections that the required writing be authenticated. Where appropriate, this report recommends this be made explicit by amending the relevant section to require authentication.

2. Authentication may pose concerns in cases where the required communication is effected electronically (a possibility which the definitions of "writing" and “data message” proposed below is designed to accommodate). The proposed definition of “authenticated” would confirm that authentication may include electronic methods of indicating the identity and approval of the authenticating party.

3. The proposed definition does not specify any particular method of authentication so as to accommodate ongoing technological changes without the need for further legislative amendment. A relative, practice-oriented, standard is adopted to assess the sufficiency of a particular method. It need be only as reliable as appropriate in the circumstances including the purpose of the communication to which the authentication relates.

3. The proposed definition is relevant to the changes proposed below to section 10(1). Under the current wording, a security interest is enforceable against third parties only where the debtor has “signed” a security agreement which describes the collateral. It is proposed to change “signed” to “authenticated”. This change would authorize the use of authenticated electronic data messages for the purposes of compliance with section 10(1).

(f) "chattel paper" means one or more writings that evidence both a monetary obligation and:

(i) a security interest in, or lease of, specific goods; or

(ii) a security interest in specific goods and accessions;

or, where the context permits, "electronic chattel paper."

COMMENT

See the proposed definition of “electronic chattel paper” and the comments on the proposed changes to sections 24 and 31 below.

(g) "collateral" means personal property that is subject to a security interest and, where the context permits, includes:

(i) proceeds, and

(ii) a supporting obligation;

COMMENT

1. Proposed clause (i) of the definition of “collateral” would confirm what is now understood; i.e. that collateral includes proceeds as elsewhere defined in section 2(1) to which a security interest extends under section 28(1).

2. Proposed clause (ii) would confirm that a reference anywhere in the Act to “collateral” automatically includes any related supporting obligation if the collateral is one of the types specified in the definition of "supporting obligation" proposed below. See further the comment on that definition.

(l) “crops” means crops, including aquatic crops, whether matured or otherwise, and whether naturally grown or planted, attached to land by roots including underwater land or forming parts of trees or plants attached to land, and includes trees only if they:

(i) are being grown as nursery stock;

(ii) are being grown for uses other than the production of lumber or wood products;

(iii) are intended to be replanted in another location for the purposes of reforestation;

COMMENT

The proposed addition of a reference to “aquatic crops” and “underwater land” in the definition of “crops” would clarify explicitly that the Act applies to crops produced in aquacultural operations. The proposed deletion of the requirement that crops be attached to land “by roots” would recognize that this requirement is inappropriate for aquatic crops which lack roots.

( ) "data message" means information contained in a communication which is generated, sent and received by electronic, optical or similar means including, but not limited to, electronic mail, telegram, telex, telecopy and electronic transfer from computer to computer using an agreed standard to structure the information.

COMMENT

1. The proposed definition of “data message” should be read along with the proposed definitions of "writing" and “authenticated.” These new definitions are designed to accommodate the use of electronic communications and electronic authentication in situations where the current wording of the Act might imply that a tangible writing or a conventional signature is required.

1. Although these provisions would not be strictly necessary in a province or territory which enacts the ULC Uniform Electronic Commerce Act, it would be in keeping with the comprehensive character of PPSA legislation for jurisdictions to accommodate technological change directly in the Act.

(m) "debtor" means:

(i) in a provision dealing with the obligation secured, a person, including a guarantor or other secondary obligor, who owes payment or performance of an obligation secured by a security interest pursuant to a transaction referred to in subsection 3(1), whether or not that person owns or has rights in the collateral;

(ii) in a provision dealing with the collateral, a person who owns or has rights in collateral, and who has given or has agreed to give a security interest in that collateral pursuant to a transaction referred to in subsection 3(1), whether or not that person otherwise owes payment or performance of the obligation secured;


(iii) where the context permits, both of the persons referred to in clauses (i) and (ii);


(iv) where the context permits, a transferor of an account or chattel paper, a consignee, and a lessee [and a buyer] pursuant to a transaction referred to in subsection 3(2);
and

(v) in sections 17, 24, 26 and 58, subsections 57(3), 59(14), 61(7) and 64(3) and section 65, the transferee of a debtor's interest in the collateral;
or

(
ii) a person who receives goods from another person pursuant to a commercial consignment;

(iii)a lessee pursuant to a lease for a term of more than one year;


(iv) a transferor of an account or chattel paper;


(vi) if the person mentioned in subclause (i) and owner of the collateral are not the same person:

(A) where the term “debtor” is used in a provision dealing with the collateral, an owner of the collateral;

(B) where the term “debtor” is used in a provision dealing with the obligation, the obligor; and

(C) where the context permits, both persons;

COMMENT

1. The proposed changes would clarify the intent of the current definition of “debtor”. Current clauses (i) and (v) are re-cast as new clauses (i), (ii) and (iii). Current clauses (ii), (iii) and (iv) are recast as new clause (iv) The reference to a guarantor or other secondary obligor in new clause (i) would makes explicit what is implicit in the current wording.

1. The square-bracketed reference to a “buyer” in proposed clause (iv) reflects a local variation: i.e. the inclusion a “sale of goods without a change of possession” as a deemed secured transaction in the Atlantic PPSAs (see further the definition of this term in the Atlantic Acts).

( ) "electronic chattel paper" means chattel paper evidenced by an authenticated writing which contains verifiable data stored in an electronic medium and not otherwise evidenced;

COMMENT

The definition proposed above is meant to expressly accommodate both tangible and electronic forms of chattel paper. See further the comments below on the proposed changes to section 24 and 31.

(u) "goods" means tangible personal property, fixtures, crops, and the unborn young of animals and includes aquatic goods produced in aquacultural operations and a computer program embodied in or accompanying the goods that is ordinarily considered part of the goods or that is an aspect of making the goods functional, but does not include chattel paper, a document of title, an instrument, a security, money or trees, other than trees that are crops, until they are severed or minerals until they are extracted.

COMMENT

1. The proposed addition of an explicit reference to a computer program in the definition of “goods” is designed to eliminate any doubt that goods includes any computer program used in the goods and ordinarily considered to form part of them or to be integral to their operation. Many programs are designed specifically for particular goods. The proposed definition would eliminate any perceived necessity under the existing law to take separate security interests in the goods and the accompanying computer program.

2. The proposed addition of the words “aquatic goods produced in aquacultural operations” is intended to eliminate any existing doubt that aquatic ‘livestock’ (e.g. farmed salmon) and aquatic crops (e.g. dulse) are included in the current definition of “goods”.

( ) "intangible" means personal property that is not goods, chattel paper, a document of title, an instrument, money or a security, and includes a licence;

COMMENT

1. The Saskatchewan PPSA, from which the proposed wording is taken, is the only Canadian PPSA to explicitly include “a licence” within the definition of “intangible.” “Licence” is then defined in the Saskatchewan Act to mean: “a right, whether or not exclusive, (i) to manufacture, produce, sell, transport, or otherwise deal with personal property; or (ii) to provide services; that is transferable by the grantee with or without restriction or the consent of the grantor.”

1. It is proposed that these definitional clarifications be added to the Model Act for potential incorporation in all the Canadian PPSAs. This would eliminate any doubt that the “personal property” in which a security interest under the PPSA can be taken includes rights under, e.g. an agricultural production quota, notwithstanding that transfer of the right is restricted or subject to the prior consent of the licensing authority.

1. This proposal reflects the consensus among Canadian common law analysts on the appropriate resolution of the issue. It also accords with judicial policy with the exception of a more restrictive line of cases in the Ontario courts. However, the Ontario cases have generated extensive criticism, and the more recent decisions from that province reflect some regret and an attitude of gradual liberalization. The proposed clarifications would eliminate any further controversy. See further G.T. Johnson, “Discretionary Licenses as Collateral” (1988-89) 3 B.F.L.R. 63; T. Johnson, “Security Interests in Discretionary Licenses under the Ontario Personal Property Security Act” (1993) 8 B.F.L.R. 123; R.M. Mercier, “Saskatoon Auction Mart: Milk Quotas and finally Some Commercial Reality” (1993) 22 Can. Bus. L. J. 466.

1. The purpose of the proposed changes is merely to ensure that a debtor can employ rights under a licence as effective collateral under a PPSA security agreement. In other words, the proposal would not impede the powers of a licensing authority, under the statutory scheme regulating the licence, to restrict transfer of the licence or condition transfer on its consent. Nor would it obligate the grantor to recognize the secured party as the new licensee.

1. This point is clarified by proposed new section 9(5) below under which a statutory provision which restricts or requires the consent of the grantor to the transfer of a licence, or the creation of a security interest in a licence, is declared ineffective but only to the extent that the provision would prevent attachment of a PPSA security interest in the license.

1. In addition, while section 57(3) of the current Saskatchewan Act empowers a secured party to enforce a security interest in a licence by giving notice to the licensee and licensor, section 58(18) then stipulates that the licensee’s rights may be disposed of only in accordance with the terms and conditions under which the licence was granted or which otherwise pertain to it. Part 2 of this Report will contain proposals to incorporate equivalent provisions into the Model Act.

1. It should be emphasized that this proposal would not permit a security interest to be taken in a licence where the statute regulating the license prohibits the transfer or the creation of a security interest in the licence. Under the definition of licence proposed below, rights under the license must be “transferable”. In this respect, the proposal does not go as far as revised article 9-408 under which it is possible to create an effective security interest in equivalent rights even where the statute regulating the right imposes an absolute prohibition on transfer. Since the grantor of the licence could not be affected adversely by the security interest (because article 9 protects the grantor in a manner similar to the PPSA as outlined in comment 4 above), the U.S. drafters felt that there was no rational basis for restricting the effectiveness of a security interest in the license.

1. The authors of this report do not share the same view. If a license is entirely non-transferable, it is generally because the legislature has determined, as a matter of public policy, that the rights embodied in the licence are wholly personal to the holder (a physician’s licence to practice being the quintessential example). To permit the holder to give a security interest in such a license would give the secured party a measure of de facto control over the debtor’s exercise of his or her rights which may conflict with the public policy basis for the personal character of the license.

( ) "licence" means a right, whether or not exclusive:

(iv) to manufacture, produce, sell, transport, or otherwise deal with personal property; or

(ii) to provide services;

that is transferrable by the grantee with or without restriction or the consent of the grantor;

COMMENT

See comment on proposed amendment to the definition of “intangible” above.

(hh) "proceeds" means:

(iv) identifiable or traceable personal property, fixtures or crops, in which the debtor acquires an interest:

(A) that are derived directly or indirectly from any dealing, whether by sale, lease, licence, exchange or disposition, with collateral; or the proceeds of collateral;

(B) in which the debtor acquires an interest;

(B) to the extent of the value of the collateral and to the extent payable to the debtor or to the secured party, a right to an insurance payment or any other payment as indemnity or compensation for loss of or damage to the collateral, or proceeds of the collateral for interference with the use of the collateral, for non-conformity of or defects in the collateral or for infringement of rights in the collateral;

(ii a payment made in total or partial discharge or redemption of an intangible, chattel paper, an instrument or a security; and

(iv) value that is collected on or distributed on account of collateral;

but does not include animals merely because they are the offspring of animals that are collateral;

COMMENT

1. The proposed additions to the definition of “proceeds” are designed to make its scope more explicit by clarifying that proceeds include rights to compensation for non-conformity of or defects in the collateral, for interference with the use of the collateral or for infringement of rights in the collateral.

1. The proposed new reference to "value that is collected on or distributed on account of collateral" would confirm that proceeds includes dividends distributed on account of investment property that is collateral.

1. The proposed deletion of the term “proceeds of collateral” in revised sub-clauses (A) and (B) is explained by the proposed addition of “proceeds” to the definition of “collateral” above.

(jj) "purchase-money security interest" means;

(i) a security interest taken in collateral to the extent that it secures all or part of its purchase price;

(ii) a security interest taken in collateral by a person who gives value for the purpose of enabling the debtor to acquire rights in the collateral, to the extent that the value is applied to acquire those rights;

(iii) the interest of a lessor of goods pursuant to a lease for a term of more than one year; or

(iv) the interest of a consignor who delivers goods to a consignee pursuant to a commercial consignment;

but does not include a transaction of sale and the lease back to the seller and, for the purposes of this clause, "purchase price" and "value" include credit charges and interest payable for the purchase or loan credit;

(jj) "purchasemoney security interest" means:

(i) a security interest taken in collateral to the extent that it secures all or part of its purchase price;

(ii) a security interest taken in collateral by a person who gives value for the purpose of enabling the debtor to acquire rights in the collateral, to the extent that the value is applied to acquire those rights;

(iii) a security interest in collateral referred to in sub- clauses (A) or (B) taken under an agreement providing for the renewal, refinancing, or restructuring of an obligation referred to in sub-clauses (A) or (B);

(iv) the interest of a lessor of goods pursuant to a lease for a term of more than one year; or

(v) the interest of a consignor who delivers goods to a consignee pursuant to a commercial consignment;

but does not include a transaction of sale and the lease back to the seller and, for the purposes of this definition, "purchase price" and "value" include credit charges and interest payable for the purchase or loan credit;

and, when the collateral is inventory, a puchase money security interest

(vi) secures any obligation arising out of a related transaction creating an interest referred to in clause (i) or (ii);

(vii) extends to other inventory in which the secured party holds or held a security interest under a related transaction that secures or secured an obligation referred to in clause (i) or (ii);

and for the purposes of sub-clauses (vi) to (vii), a transaction is related to another transaction when the possibility of both transactions is provided for in the first transaction or a prior agreement between the parties;

 

COMMENT

1. Extensive additions are proposed to the current definition of “purchase money security interest” necessitating the re-numbering of the paragraphs within the definition. The current definition appears above, followed by the proposed expanded definition.

1. The proposed new clause (iii) is designed to remove any suggestion that purchase money status is lost when a purchase money obligation is refinanced or restructured. The purchase money status would be retained in the original purchase money collateral. However, pmsi status would not extend to any new non-purchase-money collateral brought into the refinancing or restructuring. Nor would purchase money status apply to any new money or value given to the debtor over and above that used to reduce or eliminate the existing purchase money obligation.

1. The proposed new clauses (vi) and (vii) are intended to deal with the problem of cross-collateralized purchase money security interests in inventory. As a matter of strict statutory interpretation, cross-collateralization would not appear to be possible under the current definition of “purchase money security interest”. Under the current definition, the only security interest that qualifies is one “taken in collateral... to the extent that it secures all or part of the purchase price of the collateral” or one “taken in collateral (to secure value)... to the extent the value is applied to acquire the collateral.” This wording suggests that a purchase money security interest in collateral is strictly proportionate to the extent it secures the price of the collateral or the value used to acquire the collateral.

1. A secured party can, in some situations, accomplish a degree of cross-collateralization through payment allocation. Where there are two or more “pooled” pmsi obligations, the security agreement can provide that any payment made by the debtor is allocated to each obligation in proportion to the amount of the obligation, with the result that at all times the secured party has a pmsi in all collateral so long as any amount remains owing.

1. There is, however, a basis in decisions of the Saskatchewan Court of Appeal for the conclusion that the courts are prepared to recognize (or, more accurately, to overlook) some degree of cross-collateralization without the need to use payment allocation.

1. In Battlefords Credit Union Limited v. Ilnicki, [1991] 5 W.W.R. 673, the Credit Union made a consolidation loan to Ilnicki. The purpose of the loan was to pay several earlier secured purchase money obligations owing to other creditors and an earlier secured purchase money obligation owing to the Credit Union. All of the creditors had purchase money security interests in one or more of 15 items of property that were taken as collateral under the consolidation loan. The Court extended its established position [taken in Bank of Montreal v. Tomyn (1989), 84 Sask. R. 253, affirmed (1990), 87 Sask. R. 4 which involved consolidation of several purchase money loans made by the bank providing the consolidation loan] by ruling that the Credit Union acquired, under the security agreement providing for the consolidated loan, a purchase money security interest in the 15 items. The Court concluded that the consolidation loan enabled Ilnicki to “acquire rights in or to” the items within the meaning of the definition of purchase money security interest. It enabled him to rid the items of the purchase money security interests held by the prior creditors. His bundle of rights was thereby added to; his ownership was incomplete before, but complete the moment that these security interests were eliminated.

1. While the issue of cross-collateralization was not raised by counsel or addressed by the Court, one might read into the decision the conclusion that it is not relevant to inquire as to the extent that the value of each item of collateral exceeded or was less than the amount owing to the prior lender who was paid out by the Credit Union. The reason is that there was only one purchase money security interest — the one held by the Credit Union. Nonetheless, the Court concluded that the Credit Union had a purchase money security interest to the full amount of the consolidation loan. This conclusion implicitly suggests that Canadian courts may not be too demanding when it comes to demonstrating a one-to-one relationship between the collateral and obligation in order to establish a purchase money security interest.

2. The effect of this conclusion is displayed in the following scenario. Assume that only two loans were consolidated. The balance owing on the first loan was $500 and the collateral securing it was worth $1000. The second loan was for $3000 and the value of the collateral securing it was $2000. The total of the consolidated loans would be $3500 and the total value of the collateral would be $3,000. Under the position taken by the Court, the Credit Union would have a security interests in both items of collateral so long as any part of the total of $3500 of refinanced debt remained unpaid. In effect, any security interest in the first item of collateral secures on a purchase money basis debt owing on the second item.

1. In Farm Credit Corp. v. Gannon, [1993] 6 W.W.R. 736, 5 P.P.S.A.C. 52, the Saskatchewan Court of Queen’s Bench concluded that, when applying the principle established by the Court of Appeal in Ilnicki, supra, the court will not give any significance to the way in which the money supplied by the consolidation lender is applied by the recipients of the loan. In this case, the recipient of the refinancing loan had applied other money supplied by the debtor to the debt incurred in purchasing the collateral. Only a small part of the consolidation loan was applied to this obligation. The same approach was taken in Sask. Wheat Pool v. Polowick (1994), 6 P.P.S.A.C. 391 (Sask.Q.B.).

1. It is clear, therefore, at least in Saskatchewan, that consolidation of existing purchase money obligations, whether owed to the lender providing the consolidation loan or to other creditors who are being paid out, does not preclude the consolidation lender from having a purchase money interest in the collateral to secure the entire debt. This is so even though the effect may be to provide an element of cross-collateralization.

1. However, the approach taken by the Saskatchewan Court of Appeal would not facilitate the use of a security agreement that provides for prospective consolidation of advances, each secured by a purchase money security interest in collateral acquired with the advances. The Credit Union in the Ilnicki case was able to find a purchase money security interest in all of the collateral because the Court concluded that a new purchase money security interest was created by the security agreement that provided for the consolidation of the other debts. Where there is no pay out of prior security interests, this same approach cannot be used.

1. The proposed addition to the definition would expand the circumstances in which pmsi cross-collateralization is allowed (although the “related transaction” limitation addressed below would not permit cross-collateralization in the circumstances present in the Ilnicki case). The operation of the proposed changes is demonstrated in the following scenarios:

Scenario 1:

June 1: Debtor entered into a security agreement with SP1 giving it a security interest in “all present and after-acquired property.” A registration was effected.

July 1: Debtor entered into an inventory financing agreement with SP2 providing for a series of loans over a period of time to allow Debtor to purchase inventory. A registration was effected. The agreement provided that SP2 would have a security interest in the inventory. It also provided that, as each loan was made, the amount of the loan would be consolidated with amounts then owing and that the security interest in the inventory would secure the entire amount owing. Debtor was required to make payments every 30 days amounts that would be set according to the amount outstanding during the previous payment period.

August 1: Loan 1 in the amount of $10 was made and used by Debtor to purchase widgets. ( Loan 1 Widgets)

August 25: Debtor sold the Loan 1 Widgets.

August 30: Debtor made the first payment ($5) as required by the agreement. [Note that at this point, SP2 did not have a security interest to protect the remaining $5 that was owing].

September 1: Loan 2 in the amount of $10 was made and used by Debtor to purchase widgets. (Loan 2 Widgets)

September 30: Debtor made a payment of $10 as required by the agreement.

October 1: Debtor became insolvent and terminated business.

At the date of insolvency, Debtor owed $5. Assume that at this point the Loan 2 Widgets are worth $10. The issue is whether or not this debt is secured by a purchase money security interest in Loan 2 Widgets. SP1 claims priority on the basis of having first effected a registration.

Under the terms of the agreement, the $10 was simply applied to the then existing $15 debt reducing it to $5. In effect, the payment was allocated to the amounts proportionally: $3.34 to the Loan 1 obligation and $7.33 to the Loan 2 obligation. The issue is whether the balance of collateral value in the Loan 2 Widgets can be treated as securing (on a purchase money basis) the $1.66 notionally owing for Loan 1. In other words, can the Loan 1 obligation be cross-collaterally secured with the purchase money security interest in the Loan 2 Widgets?

The proposed change has been designed to permit this since the amount owing under Loan 1 is an obligation arising out of a related transaction creating an interest referred to in clause (i) or (ii). The point is that, so long as an obligation was once a purchase money obligation, it can be secured by a purchase money security interest securing any other purchase money obligation owing by the same secured party arising under a related transaction.

Scenario 2:

June 1, Debtor entered into a security agreement with SP1 giving it a security interest in “all present and after-acquired property”. A registration was effected.

July 1, Debtor entered into an inventory financing agreement with SP2 providing for a series of loans over a period of time to allow Debtor to purchase inventory. A registration was effected. The agreement provided that SP2 would have a security interest in the inventory. The agreement also provided that as each loan is to be repaid as soon as the collateral purchase with the loan has been sold. It also provides that the security interest in any of the collateral secures any amount owing by Debtor to SP2.

August 1, Loan 1 in the amount of $10 was made and used by Debtor to purchase widgets. (Loan 1 Widgets)

August 10, the Loan 1 Widgets were sold by Debtor. [Note that at this point, SP2 had no security interest in the Loan 1 Widgets.] Debtor failed to repay the August 1 loan.

August 15, Loan 2 in the amount of $10 was made and used by Debtor to purchase widgets. (Loan 2 Widgets).

August 20, the Loan 2 widgets were sold and the consideration was partly cash and partly the value of used widgets traded in by customers of Debtor.

August 21, Debtor paid to SP2 the amount of Loan 2 with the result that this loan was discharged.

September 30, Debtor became insolvent.

At the date of insolvency Debtor owed $10 to SP2 which is the amount of the unpaid Loan 1. The issue here is whether or not SP2 has a purchase money security interest in the traded in proceeds widgets to secure Loan 1. SP1 claims priority on the basis of its first in time registration.

The Saskatchewan Court of Appeal in Chrysler Credit Canada Ltd. v. Royal Bank, [1986] 6 W.W.R. 338 (Sask.C.A.) concluded that SP2 would have priority. In effect, the Court concluded that the purchase money security interest in the traded-in widgets survived the discharge of Loan 2, the loan that was secured by the purchase money security interest in the Loan 2 widgets sold by Debtor. This conclusion was thought to be unacceptable and inconsistent with the concept of purchase money security interest and was specifically reversed by section 34(10) of the SPPSA.

The proposed addition to the definition would allow SP2 to claim a purchase money security interest in the Loan 2 widgets to secure the Loan 1 obligation. However, this does not extend as well to the proceeds of the sale of the Loan 2 widgets. A purchase money security interest referred to in clauses (i) and (ii) is a security interest in original collateral and not proceeds collateral. The value must relate to the acquisition of the collateral. This does not include proceeds. This would preclude the result reached by the Saskatchewan Court of Appeal in the Chrysler Credit decision and confirm the approach taken in section 34(10) of the SPPSA.

Scenario 3:

June 1, Debtor entered into a security agreement with SP1 giving it a security interest in “all present and after-acquired property”. A registration was effected.

July 1, Debtor entered into an inventory financing agreement with SP2 providing for a series of loans over a period of time to allow Debtor to purchase inventory. A registration was effected. The agreement provided that SP2 would have a security interest in the inventory. It also provided that as each loan is made the amount of the loan is consolidated with amounts then owing and that the security interest in the inventory would secure the entire amount owing. Debtor was required to make payments every 30 days of amounts that would be set according to the amount outstanding during the previous payment period.

August 1, Loan 1 in the amount of $10 was made and used by Debtor to purchase widgets. (Loan 1 Widgets)

August 30, Debtor paid $10 as provided in the agreement. [Note that at this point, SP2 had no security interest in the Loan 1 Widgets]

September 2, Loan 2 in the amount of $10 was made and used by Debtor to purchase widgets. (Loan 2 Widgets).

The Loan 2 Widgets depreciate in value so that at the date of Debtor’s insolvency they are worth $5.

September 30, Debtor became insolvent and terminated business.

The issue here is whether, as a result of the agreement, SP2 has a purchase money security interest in the Loan 1 Widgets that secures the $5 still owing in connection with the purchase of the Loan 2 Widgets. The proposed change in the definition would recognize that it does. The proposed addition provides that the Loan 2 obligation, being a purchase money obligation, is secured by other inventory in which the secured party holds or held a security interest under a related transaction that secures or secured an obligation referred to in clause (i) or (ii). The Loan 1 Widgets are inventory in which the secured party held a security interest under a related transaction that secured an obligation referred to in clause (i) or (ii).

1. The proposed changes to the pmsi definition embodies the conceptual approach contained in UCC 9-103(b) but is more limited in that it restricts cross-collateralization to a "related" transaction. The new concept of cross-collateralization would give a pmsi financier priority with respect to any collateral that was formerly subject to a pmsi to secure undercollateralized debt arising under separate pmsi transactions. This is legitimate where there is some relationship between the two pmsi transactions. However, where the transactions are unrelated, general ‘background’ lenders might be reluctant to extend secured financing to small businesses without assurance that their debtors' interests in property formerly subject to pmsis will not be subject to new pmsis created under entirely separate transactions entered into after the original pmsi has been paid out. In order for this concern to be addressed, it is necessary to preclude ex post facto consolidation of pmsi obligations. In other words, it would not be possible for the parties to enter into a consolidation agreement providing full crosscollateralization of obligations arising under prior separate agreements (as was done in the Ilnicki case supra). This is a legitimate restriction. If the parties contemplate a continuing relationship, this should be established from the beginning. The law should facilitate crosscollateralization where there is a continuing relationship that involves pmsis so that the secured party need not keep separate accounts for each separate subtransaction as the current definition requires. Beyond this, there is a risk of prejudice to prior secured creditors of the same debtor.

(nn) "secured party" means:

(i) a person who has a security interest in whose favour a security interest has been created or provided for pursuant to a transaction referred to in subsection 3(1), whether for that person’s benefit or for the benefit of another person;

(ii) a person who holds a security interest or for the benefit of another person; or

(iii) (ii) a trustee, where a security interest is embodied or provided for in a trust indenture; or

(iii) where the context permits, a transferee of accounts or chattel paper, a lessor, and a consignor [and a seller] pursuant to a transaction referred to in subsection 3(2).

COMMENT

1. The proposed terminological changes in clauses (i) and (ii) are designed to eliminate any implication that a person is a secured party for the purposes of applying the provisions of the Act only after a security interest has come into existence.

2. The above proposal also deletes clause (ii) of the existing definition and incorporates its substantive thrust into revised clause (i).

2. The changes proposed above are also intended to directly alert the reader to the fact that the term “secured party” in the PPSA includes both secured parties in the true sense and secured parties under a deemed security transaction. This is the purpose of new clause (iii) and the new reference in clause (i) to a secured party under a section 3(1) transaction. Under the current definition, the same substantive result is effected indirectly by a cross-reference in clause (i) to the term “security interest” which is defined to include both true and deemed security interests.

2. The square-bracketed reference to a “seller” in new clause (iv) reflects a local variation (i.e. a seller under a “sale of goods without a change of possession” is a deemed secured party in the Atlantic Province PPSAs: see further the definition of this term in the Atlantic Acts).

(qq) “security interest” means:

(i) if the interest arises under a transaction referred to in subsection 3(1), an interest that secures payment or performance of an obligation, but does not include . . .

(ii) if the interest arises under a transaction referred to in subsection 3(2), the interest of:

(A) a transferee pursuant to a transfer of an account or a transfer of chattel paper;

(B) a consignor who delivers goods to a consignee pursuant to a commercial consignment;

(C) a lessor pursuant toa lease for a term of more than one year;

[(D) a buyer under a sale of goods without a change of possession];

whether or not the interest secures that does not secure payment or performance of an obligation.

 

COMMENT

1. The proposed addition of a cross-reference to sections 3(1) and 3(2) in clauses (i) and (ii) of the current definition of “security interest” would clarify that the reference to “security interest” in section 3(1) is confined to a ‘true’ security interest as defined in clause (i), and that clause (ii) relates solely to the ‘deemed’ secured transactions in section 3(2).

1. The proposed change to the concluding words of clause (ii) already has been made in the Atlantic PPSAs. This change is intended to eliminate any potential for overlap between a ‘true’ security interest as defined in clause (i) and the deemed security interests listed in paragraph (ii). The proposed change would bring clause (ii) into line with the concluding words of section 3(2) of the Act where the relevant change already has been made.

1. The square-bracketed reference to a “sale of goods without a change of possession” in new clause (iv) reflects a local variation: i.e. the inclusion of the non-possessory interest of a buyer of goods as a deemed security interest in the Atlantic PPSAs (see further the definition of “sale of goods without a change of possession” in these Acts).

( ) "supporting obligation" means a secondary obligation that supports the payment or performance of an intangible, chattel paper, a document of title or an instrument.

COMMENT

1. “Supporting obligation” is a proposed new term defined to mean guarantees and other secondary obligations taken to support a primary obligation associated with an intangible, chattel paper, a document of title or an instrument. The express recognition of “supporting obligations” would confirm the principle, implicit in current law, that a supporting obligation is an automatic incident of the collateral it supports.

1. Although the proposed definition is similar to that found in revised article 9-102, this report does not propose specific rules to govern the attachment, perfection, and priority status of supporting obligations equivalent to those found in revised articles 9-203, 9-308, 9-310 and 9-322. As noted above, it is instead proposed to revise the definition of “collateral” to include a “supporting obligation” so that a reference anywhere in the Act to “collateral” would include any supporting obligation associated with that collateral. Under this approach, attachment and perfection of a security interest in a supporting obligation would occur automatically on the attachment and perfection of a security interest in the collateral to which the supporting obligation relates, and the priority status of the supporting obligation would follow that of the related collateral.

(uu) "writing" and "in writing", except in sections 2(o) [document], 2(v) [instrument] and 2(oo)[security] include a data message, if the information contained therein is accessible so as to be usable for subsequent reference.

COMMENT

See the comments above on the proposed new terms “authenticated” and “data message.”

Sections 2(5) and 2(6) – Distinction between ‘True’ Leases and ‘Security’ Leases

(5) Unless the relevant circumstances clearly indicate otherwise, a transaction in the form of a lease is a security agreement if:

(a) the period of the lease is substantially equal to or greater than the period during which the property is suitable for the purposes for which it was designed and the period cannot be terminated at the election of the lessee;

(b) upon the expiry of the one or more initial periods, the lessee is bound to renew the lease for the balance of the period during which the property is suitable for the purposes for which it was designed or is obligated to purchase the property;

(c) at the expiry of one or more initial periods, the lessee has the option to renew the lease for the balance of the period during which the property is suitable for the purposes for which it was designed for no additional value or for a value that is significantly below the market lease rate for the property at the time the option is exercised, unless the market lease rate is greater than the amount payable by the lessee under the option because of changes in the market for the property that could not reasonably have been contemplated by the parties at the time of execution of the lease;

(d) at the expiry of one or more initial periods, the lessee has the option to become the owner of the property for no additional consideration or for a consideration that is significantly below the fair market value for the property at the time the option is exercised, unless the fair market value is greater than the amount payable by the lessee under the option because of changes in the market for the property that could not reasonably have been contemplated by the parties at the time of execution of the lease;

(e) prior to execution of the lease, the property was owned and used by the lessee and thereafter sold to the lessor;

(f) at the expiry of one or more initial periods the leased property is to be sold and the lessee, whether or not entitled to be paid a surplus, is obligated to pay to the lessor a deficiency, when the deficiency or surplus is calculated by comparing the amount recovered from the sale and an amount specified in the contract.

(6) The following factors, without more, shall not be considered as indicating a security lease:

(g) the present value of the lease payments is equal to or greater than the fair market value of the property at the time of execution of the lease;

(h) subject to subsections (5)(c) and 5(d), the lessee has an option to renew the lease or to become the owner of the property.

COMMENT

1. Neither the Model Act nor any other Canadian PPSA contains guidelines equivalent to UCC §1-201(37) for determining when a lease is in substance a security agreement. Generally this has not been a problem for two reasons. First, all PPSA jurisdictions except Ontario, subject true leases of a specified duration to the perfection and priority rules of the Act. This leaves a very small area (enforcement) for disputes to arise over the characterization issue. Second, the Canadian courts, for the most part, have shown themselves to be adept in applying the PPSA substance test to the characterization issue. However, some have not made the transition in their thinking. In addition, there is no provincial court of appeal that has directly addressed the issue and the potential remains for a fundamental misunderstanding of the conceptual underpinnings of the system as occurred in the British Columbia Court of Appeal decision in Re Giffen (1966), 16 B.C.L.R. 29 (reversed on appeal to the Supreme Court of Canada (1998), 155 D.L.R. (4th) 332).

1. The proposed new provision generally tracks UCC §1-201(37) with one notable exception. There is no equivalent in the UCC to proposed subsection (5)(f). The omission is difficult to explain. The bulk of case law in the United States has characterized open-end leases as security agreements. See the discussion of open-end leases in comment 7.

1. It is not possible to prescribe a ‘formula’ that will in all cases resolve the issue of whether a lease is a security lease or a ‘true’ operating lease. Any particular lease contract may have characteristics of each type of transaction. What is required is to balance the factors that point to a true lease against those that point to a security lease and to make the determination on the basis of which set of factors predominates. The formulation set out in the proposed provision would create an irrefutable presumption that a transaction in the form of lease is a security agreement if, in the absence of countervailing factors, the agreement is in a form that falls within one of the clauses of the subsections.

4. One of the basic features of a secured contract for the sale of movables is that ownership in the property is transferred to the buyer upon performance of his or her obligations under the contract. While the presence of terms in a transaction under which the lessee is obligated to buy and the lessor is obligated to sell the property inevitably results in the transaction being characterized as a security lease, it does not follow that the absence of such terms dictates the conclusion that the transaction is a true lease and not a security lease. Passage of ownership or title in a technical sense should not be relevant to characterization under section 3. However, ownership in a non-technical sense is. If the practical effect of a transaction labelled a lease is to give the lessee most of the incidents of ownership but not legal title, the transaction is in substance a security lease. The primary incidents of ownership relevant in this context are: (i) use of the property for its full or substantially all of its useful life (i.e., the balance of the period during which the property is suitable for the purposes for which it was designed), generally accompanied by an obligation to pay the equivalent of at least the capital cost of the property plus the cost of the money invested in it by the lessor), (ii) the acquisition of a substantial "interest" in the property, and (iii) the loss or gain from unusual depreciation or appreciation in the value of the property.

5. If the lessee is required to pay what is the equivalent of the lessor's capital investment plus a credit charge at the rate existing at the date of the agreement, it does not follow that a security lease is involved. The lessee may simply have agreed to pay a premium for use of the leased equipment. However, a clause in a lease giving the lessee the option to purchase the property at less than its expected market value (as determined at the date of execution) indicates that the lessee has acquired an equity in the property not unlike that which it would have acquired under a purchase contract. The economic reality is that it is quite predictable the lessee will pay this amount to the lessor. Consequently, the transaction is a security lease. However, the fact that at the end of a lease term roughly equivalent to the useful life of the property the lessee can purchase the property at its then market value does not prevent characterization of the transaction as a security lease. A consideration of the option price is relevant to the characterization of the transaction only if the option can be exercised at a time when the property has a significant commercial value.

6. Some leases provide that rental payments made up to the point when the option is exercised are to be "credited" to the lessee and deducted from the amount payable under the option. Under a substance test, the amount "credited" to the lessee has little significance; it remains necessary to determine if the amount of new money to be paid by the lessee represents the reasonably expected fair market value of the property at the time of exercise of the option. If the new money is equal to or near the market value of the property, the "credit" is of no significance. If the amount of new money is significantly less than the market value of the property, the term providing for the credit is an overt recognition that the lessee has purchased an "equity" in the property through its lease payments. It is inevitable that, as a rational person, the lessee will exercise the option in order to realize that equity.

7. One of the more popular types of leases currently in use is the "open-end" lease. While a variety of different provisions are used in these leases, the general pattern is to fix the term for a period less than the useful life of the property. The lease provides that at the end of the term the property will be returned to the lessor who will then sell it. The lessee may purchase the property from the lessor at its appraised value. Whether the lessee or a third person buys the property, the lessee agrees to pay the lessor the difference between the amount recovered by the lessor on the sale of the property and a predetermined amount specified in the lease. If the sale yields more than this amount, the surplus is to be paid to the lessee. Since the term is for less than the useful life of the property and it is not predictable, as a matter of economic realities, that the lessee will purchase the property at the end of the lease term, one might conclude that this type of transaction is a true lease. However, when other aspects of an open-end lease are examined, it becomes clear that the transaction is more properly characterized as a security lease. Under an open-end lease, the lessor has no right to retake the leased property and assert ownership over it at the end of the lease term. The property is returned to the lessor at the end of the term solely for the purpose of sale. Any unusual depreciation or appreciation of the property while it is in the hands of the lessee accrues to the lessee and not the lessor. Accordingly, the lessee is the person who has the "equity" in the property; it is the one who is affected by the price obtained upon sale of the property by the lessor.

7. The fact that the lessee bears some of the obligations of ownership, such as the requirement to repair and insure the property, provides some, but only weak, evidence of a security lease. These factors are not of sufficient weight to be mentioned in the statutory list of factors.

Next Annual Meeting

2018 Conference (Centennial)

Delta Hotel

Québec City, QC

August 12 - 16, 2018