On November 26, Quebec's Finance Minister tabled a bill intended to amend the provisions of the Civil Code of Quebec (CCQ) concerning hypothecs (security interests). This update provides a summary of the proposed changes.
The proposed changes relate to (i) hypothecs granted in favour of an agent for the benefit of present and future creditors, and (ii) hypothecs on bank deposits and certain other monetary obligations.
Hypothecs granted to an agent for a group of creditors
Under personal property legislation in the common-law provinces, security may be granted in favour of an agent for present and future creditors ("collateral agent" or "security agent"). Currently, article 2692 CCQ permits the granting of security to such a representative (described in the CCQ as a person holding a "power of attorney" for the creditors) only if the obligations secured are debt securities such as bonds or debentures.
Therefore Quebec law currently does not contemplate that a borrower directly grant to an agent representing a syndicate of lenders a hypothec securing loans that may be made to the borrower by existing or future members of the syndicate. To achieve an equivalent result, a number of techniques have been developed by legal practitioners. For example, a borrower may issue a debenture secured by a hypothec on its assets in favour of an agent who will act for the benefit of the holder(s) of the debenture. The debenture is then pledged in favour of the syndicate members, who become holders of that debenture and may demand payment thereof if the borrower defaults under the loans. If the borrower fails to pay the debenture, the agent may realize the hypothec and the proceeds of realization will be applied to the repayment of the debenture; these proceeds will be distributed to the lenders in their capacity as holders of the debenture. Finally, as the debenture is held as security for the loans, the funds received will be applied to these loans.
The technique described above (two levels of security) is unduly complex and often not well understood by borrowers and lenders. Under the proposed amendments, the use of this technique will be no longer necessary. It will be possible to secure loans made by a syndicate of lenders by granting to an agent of the lenders a hypothec directly securing the loans in a manner similar to existing practices in the common-law provinces and the United States.
This proposed modernization of Quebec law was the subject of a recommendation by the Québec Bar some years ago. It will also resolve a controversy on the scope of the current text of article 2692: the Superior Court of Quebec had interpreted that provision as requiring that a hypothec securing a debt security be granted by notarial deed even if the hypothec is directly granted to the holder of the debt security (i.e. even if the hypothec is not granted to a representative of other holders of debt securities).
Security on bank deposits
The proposed amendments create a new regime for security interests in bank deposits and certain other monetary obligations. The proposal has been inspired from article 9 of the US Uniform Commercial Code.
The present summary is confined to security interests in bank deposits; the new regime in its entirety will be discussed in a future update. It should be noted, however, that Bill 28 indirectly recognizes the effectiveness of a set-off agreement as a security device.
The term "bank deposit" is used here as a short-hand. The proposed legislation applies to any deposit with a financial institution receiving deposits from the public (e.g. a bank, credit union, trust company, etc.). In essence, the new regime will enable clients of a financial institution to grant a security interest in their deposits pursuant to the methods provided by US law (which methods are not currently contemplated by Quebec law):
- If the client wishes to grant a security interest to the financial institution with which the deposit is made, the security will automatically become valid and perfected upon the client giving written consent to its deposit being retained as security. This method may be used where the depositary institution is already a creditor of the client or intends to extend credit to the latter on the security of the deposit.
- If the client wishes to grant a security interest to a third party, i.e. to a creditor who is not the depositary institution, the security will become valid and perfected once the client, the creditor and the depository institution have agreed in writing that the creditor will have the power to dispose of the deposit without the client's intervention. This agreement (known as a "control agreement"), if the parties so desire, may authorize the client to make withdrawals until the creditor revokes the authorization. It must be noted, however, that a client of a financial institution cannot compel the institution to become party to a control agreement.
Security granted using any one of the above methods does not need to be registered. It also confers on the creditor a "super-priority". For example, if a company grants to Bank X a hypothec on all its present and future receivables and if the company subsequently grants to Bank Y a hypothec on its deposits with Bank Y, Bank Y's hypothec would rank prior to Bank X's hypothec even if that hypothec had already been registered in the Quebec's security registry.
Finally two points should be kept in mind. First, this new regime is available not only to corporations, trusts and partnerships, but also to consumers (although in the latter case, RRSP-related deposits and certain others are excluded). Second, it will still be possible to hypothecate bank deposits without using the above methods; in that case, however, a registration would have to be effected in the Quebec's security registry in order to achieve perfection.