Introduction

In addition to its geographical proximity to, and robust trading partnership with, the U.S., a key reason Canada is perceived as a favorable place for secured lending is that Canadian and American laws of secured transactions share many commonalities. In fact, Article 9 ("Article 9") of theUniform Commercial Code (the "UCC") was the template for the Personal Property Security Act (Ontario) (the "PPSA"). Since then, all of the other common law provinces and federal territories in Canada have enacted their own personal property security legislation that is substantially similar to the Ontario PPSA.1 As such, most of the legal concepts and rules central to secured lending in Canada are already familiar to U.S. lenders.

It is critical, however, for U.S. lenders operating in the Canadian market to understand the key differences between the PPSA and the UCC, as such differences can have serious consequences for the validity, priority and perfection of their security interests. One of these key differences currently receiving attention in Canada concerns security in cash. 

Security in Cash under Article 9: Perfection by Control

A secured lender's security interest in cash needs to be perfected in order to (i) notify future creditors of the debtor that the secured lender has or may have a security interest in the debtor's cash, and (ii) protect its security interest against competing claims to the cash made by the debtor's trustee in bankruptcy (if the debtor becomes bankrupt) or judgment creditors.2 Under Article 9, a security interest in a commercial deposit account3 may be perfected by "control." A secured party can obtain control in a deposit account under Article 9 in one of three ways. First, the secured party will automatically have control if it is the bank that maintains the deposit account in the debtor's name.4 Second, where the secured party is not the deposit bank, it can obtain control by entering into a control agreement with the debtor and the deposit bank.5 A control agreement is an agreement pursuant to which the deposit bank agrees to comply with the secured party's instructions regarding the disposition of funds in the deposit account without the debtor's further consent. The third way in which a secured party can obtain control in a deposit account is by becoming the bank's customer with respect to the deposit account, thereby gaining the right to dispose of funds in the deposit account.6

In the event of competition between multiple security interests in the same deposit account, the priority rules set out in Section 9-327 of Article 9 apply, and a secured party perfected by control prevails over competing secured parties who do not have control.7 Where two security parties have control of a deposit account—conceivable because control can be obtained in three ways—they rank according to priority in time of obtaining control, with first priority accorded to the secured party who obtained control the earliest.8 Finally, if the bank maintaining the deposit account has control, that bank ranks in priority to all competing secured parties except for one who becomes the bank's customer with respect to that deposit account.9

Security in Cash under the PPSA: Perfection by Registration

Unlike Article 9, the PPSA does not include a control regime for deposit accounts or other forms of cash as collateral. Rather, the sole method available for perfecting security interests in cash collateral is pursuant to registration in the PPSA registry. The PPSA registration system is similar to the notice filing system established by Article 9. A secured party files a financing statement, which presents basic information about a security agreement that the secured party did or will enter into, including the names and addresses of the parties, a skeletal description of the collateral (often no more than an indication of the collateral classes), and the duration of the registration.10 

From a secured lender's perspective, perfection by registration has several shortcomings as a method of perfecting a security interest in cash as compared to perfection by control. Having control of cash collateral in accordance with Article 9 provides a secured lender with more certainty with respect to priority of its security interest in such cash collateral. Conversely, the priority rules in the PPSA with respect to cash collateral are complex and contain numerous exceptions, which means, unlike perfection by control as provided by Article 9, perfection by registration under the PPSA does not guarantee the secured lender certainty with respect to priority over competing secured parties. For example, consider a situation where one secured party ("Secured Party A") holds a security interest in a deposit account, and the credit balance in that deposit account represents the proceeds of the sale of a piece of collateral that was subject to a security interest in favour of another secured party ("Secured Party B"). According to PPSA rules, Secured Party B's security interest could enjoy super-priority over Secured Party A's security interest in the resulting cash collateral given by the debtor.11 In other words, the priority rule that the secured party that is first to register its security interest gains priority over all other secured parties who register subsequently,12 which generally governs competition among perfected security interests under the PPSA, does not apply in these circumstances.13 For this reason, secured parties holding cash collateral cannot be certain as to priority under the PPSA merely by perfecting their security interests by registration. In contrast, the Article 9 control regime establishes much simpler priority rules for cash collateral, capable of giving lenders with control of such collateral assurance of priority over other secured lenders without control.

OBA Proposal for amendments to Ontario PPSA

The trend toward harmonization of Canadian and U.S. law on security in cash collateral appears to be gathering momentum. In February 2012, the Ontario Bar Association submitted a proposal (the "OBA Proposal") to the government of Ontario, recommending amendments to the PPSA to establish a control regime for perfecting security interests in cash collateral. The stated purpose of these proposed amendments is "to facilitate the use of cash ... as collateral for loans and other secured obligations."14 The OBA Proposal is largely modeled on the Article 9 control regime.15

The OBA Proposal has become a significant impetus behind legislative reform of the law on security in cash collateral in Canada. In its 2012 budget working papers, the government of Ontario announced, "plans to propose legislative changes ... to make it easier for businesses and financial institutions to provide or obtain a first priority security interest in cash collateral."16 Unfortunately, when the official budget was passed, it did not include the amendments proposed by the OBA.17 A recent change to Québec law, however, furnishes another positive sign that Canadian lawmakers are increasingly receptive to reforms that bring their secured lending legislation into greater alignment with the UCC. On April 21, 2015, the Québec government amended its Civil Code to facilitate the perfection of security interests in cash collateral by control in a manner similar to Article 9. This legislative reform was referenced in Ontario by a panel of experts on the PPSA who, once again, recommended the introduction of a control regime to the PPSA with respect to cash collateral in order to harmonize the PPSA with Article 9 as well as the provisions of Civil Code of Quebec governing security interests in cash collateral.18

Practical Considerations in the Meantime

Until the PPSA is actually amended to establish a control regime with respect to cash collateral similar to Article 9, U.S. secured lenders into Canada need to understand and plan for the differences between the current PPSA rules and Article 9 discussed above. Lenders taking a security interest in cash collateral should: (a) continue to register a PPSA financing statement against the debtor in the appropriate PPSA jurisdiction, and (b) conduct PPSA searches against the debtor in such jurisdiction and negotiate with those secured parties with prior-perfected (and hence higher-ranking) security interests in the same cash collateral for subordination, waiver or estoppel agreements.

As an additional step, lenders should consider entering into a deposit account control agreement (the "DACA") with the financial institution that maintains the cash collateral in Canada, even though such an agreement does not relate to perfection of a security interest in most of Canada. Ideally, where the debtor is a U.S. entity, the DACA should expressly state that it shall be governed by U.S. law (for example, the law of the state of New York). This step assists with issues arising from the differences between the conflict of law rules in Article 9 and those in the PPSA. The PPSA conflict rules provide that the law governing the validity, perfection and priority of a security interest in intangible assets (such as a deposit account) is determined by the debtor's jurisdiction, which is usually the location of the debtor's chief executive office.19 In contrast, the Article 9 conflict rule points to the "local law of [the] bank's jurisdiction."20 Consider the following situation: a New York-based subsidiary of an Ontario borrower provides a guarantee of the borrower's indebtedness by granting to the lender a security interest in a deposit account maintained by a Toronto-based bank.21 The law governing the deposit account would be New York law pursuant to the PPSA conflict rules (since the debtor's jurisdiction is New York), whereas the Article 9 conflict rules would point to Ontario law as the applicable law (since the deposit bank's jurisdiction is Ontario). This legal conundrum could potentially cause the lender's security interest in the deposit account to be found unperfected, if the court held that New York law governed the security interest and the lender had not perfected by control in accordance with Article 9, or if the court applied Ontario law and the lender had not perfected by registration under the PPSA.

To avoid the foregoing difficulties associated with conflict of laws, the secured lender in the situation discussed above can enter into a DACA with the deposit bank and the debtor, which expressly provides that the governing law is New York law. Such "governing law" provision has two salutary effects from the secured party's perspective. First, it precludes the courts from applying the PPSA to determine the interpretation of the DACA and the underlying deposit account. Second, the governing law provision of a DACA determines the "local law of [the] bank's jurisdiction" for the purposes of Article 9 conflict of law rules.22 Thus, although the deposit bank is located in Toronto, it is the law of New York, and not of Ontario, that governs the perfection and priority of the lender's security interest in the deposit account. Therefore, by entering into the DACA the lender achieves perfection by control in accordance with Article 9. The challenge with this approach may be in convincing a deposit bank based in Canada to enter into a DACA governed by foreign law.

Conclusion

For secured lenders looking to globalize their business, Canada is, and will likely remain, an attractive market. The similarities between Canadian and U.S. laws relating to secured lending provides some comfort to lenders looking to engage in cross-border lending deals between Canada and the U.S. Nonetheless, U.S. lenders should take great care to understand the differences between the PPSA and Article 9, especially those differences with respect to perfection of security interests in cash collateral. Whereas Article 9 facilitates perfection by control, the PPSA currently does not and, instead, requires registration in order to perfect security interests in cash collateral. Such differences between the two regimes can create difficulties for lenders, including the uncertainty of priority and the conflict of laws issues discussed above. Although there is a trend toward harmonizing Canadian law with the UCC with respect to perfecting security interests in cash collateral, it is unclear when the proposed reforms will be legislated in Ontario or the other PPSA jurisdictions. In the meantime, U.S. secured lenders need to take the necessary steps in perfecting their security interests in cash collateral in cross-border deals.