Possible Changes to the Canadian Personal Property Security Acts 2000

Section 31 – Priority of Holders and Purchasers of Money and Documentary Intangibles

31.(1) A holder of money has priority over a security interest in it perfected pursuant to section 25 or temporarily perfected pursuant to subsection 28(3) if the holder:

(a) acquires the money without knowledge that it is subject to a security interest; or

(b) is a holder for value, whether or not the holder acquires the money without knowledge that it is subject to a security interest.

31.(2) A creditor who receives payment of a debt owing by a debtor through a debtor-initiated payment has priority over a security interest in:

(a) the funds paid;

(b) the intangible that was the source of the payment; and

(c) any instrument used to effect the payment;

whether or not the creditor has knowledge of the security interest at the time of the payment.

31.(3) In subsection (2), "debtor-initiated payment" means a payment made by the debtor through the use of:

(a) an instrument or an electronic funds transfer; or

(b) a debit, a transfer order, an authorization or a similar written payment mechanism executed by the debtor when the payment is made.

(6) For the purposes of subsections (4), and (5) and (7), a purchaser of an instrument, or a security, or chattel paper or a holder of a negotiable document of title who acquired it pursuant to a transaction entered into in the ordinary course of the transferor’s business has knowledge only if the purchaser or holder acquired the interest with knowledge that the transaction violates the terms of the agreement that creates or provides for the security interest.

(6.1) Subject to section 28, the priority which a holder of money, an instrument, a security or an negotiable document of title has under this section extends to proceeds.

31.(7) A purchaser of chattel paper who takes possession of it in the ordinary course of the purchaser's business and for new value has priority over any security interest in the chattel paper that:

(a) was perfected as a security interest pursuant to section 25 or 28, if the purchaser does not have knowledge at the time of taking possession that the chattel paper is subject to a security interest; or

(b) has attached to proceeds of inventory pursuant to section 28.

31(7) A purchaser of chattel paper, including electronic chattel paper, has priority over another perfected security interest in the chattel paper if:

(a) the chattel paper is acquired for new value and in the ordinary course of business of the purchaser;

(b) the purchaser acquires the chattel paper without knowledge of a prior perfected security interest in it;

(c) the purchaser takes possession of the chattel paper; and

(d) the chattel paper is not specifically inscribed with the name of another purchaser.

COMMENT

1. The proposed new section 31(6.1) would make it clear that the special priority position of a holder of money and a transferee of a negotiable instrument, a security or a negotiable document of title carries over to the proceeds of the property. This proposal would bring section 31 in line with section 34. Consider the following scenario:

SP1 obtains and registers a security interest in all present and after-acquired property of Debtor. SP2 takes a security interest in a negotiable instrument payable to debtor and perfects by taking possession of it. SP2 releases the instrument to Debtor who collects the value of the instrument and takes the proceeds (cash) and deposits it in a bank account. Within 15 days thereafter, SP2 registers a financing statement describing the collateral as accounts pursuant to section 26(1).

1. If SP2 is not given the same priority status with respect to the account that it had with respect to the instrument, its security interest in the instrument is of limited value. The instrument as such has no intrinsic value (except as a piece of paper). It must be collected in order to have commercial value. If the priority status given to the instrument is not extended to the proceeds, the policy of section 31(3) is defeated. There is no point in having priority as holder of an instrument if the conversion of that instrument into proceeds (other than money which the secured party takes into possession thereby bringing itself within section 31(1)) results in the loss of that priority status.

1. Admittedly, the approach contained in the proposed section 31(6.1) would place SP1 in the position of not being able to rely on the registry when assessing its priority position. In other words, before lending money to Debtor on the security of the account, SP1 would have to determine whether the account was proceeds of cash or a negotiable instrument, a security interest in which was perfected by possession. SP1cannot simply conclude that, since it has registered first, it will have priority to the account.

1. However, this is not a matter of great commercial importance. The scenario involves a very narrow range of transactions. The situation does not have the commercial importance for accounts financing that inspired section 34(5) of the Act. If SP1 has a general assignment of accounts, the one account to which it would not have priority as a result of this approach would be of little concern. If it has an assignment of the specific account and it is concerned about its priority position, all it needs to do is to contact SP2 to determine the origins of the account. This is not a situation in which SP2's interest is undisclosed (other than during the short period referred to in section 28(3)). [It should be noted that this would not be the case in Ontario where proceeds in the form of accounts need not be described in a financing statement.]

1. Proposed sections 31(2) and (3) are a reformulated version of the original sections to take explicit account of the emergence of electronic funds transfer systems. These sections already appear in the Saskatchewan PPSA and in the PPSAs of a number of other provinces but have not yet been enacted in the Atlantic PPSAs.

1. Current section 31(7) distinguishes between the priority of non-inventory financiers and the priority of other secured parties as against a new purchaser for new value who takes possession of the chattel paper in the ordinary course of the purchaser’s business. The proposed reformulation would eliminate this distinction thereby enabling inventory financiers to preserve priority in chattel paper which is proceeds of inventory by monitoring the debtor’s handling of the paper to ensure that their name is inscribed on it as the purchaser. Under the current section, this is not possible since the inventory financier is subordinated to a subsequent purchaser for new value even if the purchaser takes with knowledge of the inventory financier’s prior competing security interest. In contrast, non-inventory financiers retain their priority under the current section over a purchaser who acquires the chattel paper with knowledge of their security interest. Accordingly, they are able to preserve their priority by ‘marking’ the specific chattel paper so as to effectively give notice to subsequent purchasers. Inventory financiers who wish to preserve their priority must go further and take actual possession of the paper. But if, as proposed earlier, ‘marking’ of chattel paper is accepted as the functional equivalent of taking physical possession under section 24 for perfection purposes – a proposal which would accommodate the use of electronic chattel paper – it would be illogical to preserve the current distinction in section 31 between the effects of notice in the case of inventory and non-inventory prior financiers. The proposed reformulation would therefore eliminate the distinction. This proposal also reflects the authors’ recognition that the concerns posed by the commercial financing patterns which existed when the distinction was first introduced, and which prompted the distinction, are no longer present.

1. It is also proposed to include chattel paper purchasers within subsection 31(6). As a result of this change, a purchaser of chattel paper has knowledge sufficient to defeat its priority under subsection (7) only if the chattel paper is acquired with knowledge that the transaction violate the terms of the security agreement between the debtor and a prior perfected secured party. This change would ensure that the priority of a chattel paper purchaser for new value is not defeated by the accidental acquisition of knowledge of a competing registered interest against e.g. “all present and after acquired personal property” or “all goods and proceeds”. This change would not, however, eliminate ‘marking’ as a means for prior secured parties who are actively monitoring the debtors’ chattel paper to preserve their priority claim in specific paper. Under the reformulated subsection (7), the purchaser would take priority only if the specific paper is not already inscribed with the name of a competing claimant.

1. Much more substantial change to section 31 will be required on implementation of the proposed Uniform Securities Transfer Act.

Next Annual Meeting

2018 Conference (Centennial)

Delta Hotel

Québec City, QC

August 12 - 16, 2018