The Supreme Court of Canada has recently ruled on two priority disputes among secured creditors holding security over personal property. At issue in both cases were the competing rights between a prior unregistered security interest and a subsequent security interest that was registered under the Bank Act (Canada) but was not registered under the relevant provincial Personal Property Security Act (PPSA).

The Supreme Court of Canada held that a bank seeking to rely upon the Bank Act to support its rights in collateral can acquire no greater interest in that collateral than the debtor has at the time that the security interest is granted. Even if at the time of taking its Bank Act security the bank has no practical way of knowing that a prior unregistered security interest exists, simply registering a security interest in accordance with the Bank Act will not give the bank priority over that prior unregistered security interest.

In order to most effectively maintain priority over unregistered security interests, a bank must perfect its security interest in personal property (by registration or otherwise) in accordance with the applicable provincial Personal Property Security Act.

Decisions of the Supreme Court of Canada

The two Supreme Court of Canada decisions referenced above are based upon highly similar fact patterns. The chronology of events, in very general terms is as follows:

Time Point 1: The original secured creditor provides financing to the borrower and takes a general security interest to secure the repayment obligation. The original secured creditor does not immediately perfect its security interest in accordance with the applicable provincial Personal Property Security Act.

Time Point 2: A Canadian financial institution to which the Bank Act applies provides financing to the same borrower and takes a general security interest in respect of which a notice of intention is registered in accordance with the Bank Act.

Time Point 3: The original secured creditor registers its security interest in accordance with the applicable provincial Personal Property Security Act.

Time Point 4: The borrower defaults on its loans from both secured creditors, and the financial institution with Bank Act security takes enforcement steps under its security and a priority dispute arises.

The primary difference between the two Supreme Court of Canada decisions is the subject collateral. In one case, the disputed collateral was already in possession of the borrower at the date that the competing creditors each took their security interests. In the other case, the borrower did not come into possession of the disputed collateral until after both competing creditors had taken their security interests in present and after acquired property.

In either case, the Supreme Court of Canada held that the original secured creditor, regardless of the fact that its registration post-dated the bank’s Bank Act registration, took priority.

In both cases, the court’s decision was built on the premise that the Bank Act security regime is “proprietary-based”. Therefore, the security interest acquired by the bank asserting its rights under the Bank Act must be evaluated based upon the proprietary interest that the debtor had in the collateral at the time that security was granted. The court determined the security interest taken by the original secured creditor in either case to be analogous to a proprietary right, thus limiting the rights that the borrower had in the collateral at the time of the grant of security to the bank. Simply put, the bank could not use the Bank Act to assert a security interest in collateral that was already subject to a pre-existing proprietary interest of a third party (such as a security interest), regardless of whether that proprietary interest was or was not registered or otherwise perfected.

The court was unmoved by attempts to draw any distinction between priority rights for security interests in after-acquired property and security interests in collateral existing on the date of execution of a security agreement. The court explained that at the time of execution of its security agreement, the original secured creditor acquired a statutory interest in the nature of a fixed charge over the borrower’s after-acquired property, which effectively derogated from the proprietary rights that the borrower had available to assign to the bank in that same after-acquired property.

The court also considered the reality that there was, practically speaking, no way that the bank could have known of the pre-existing security interest encroaching on the priority of its Bank Act security interest. The court acknowledged this issue but held that it could not be remedied given the language of the existing provisions of the Bank Act.

Following these decisions, a bank must register its security interest in personal property in accordance with the relevant provincial Personal Property Security Act in order to ensure that its priority rights are protected and cannot place reliance upon the Bank Act for that purpose.

The above decisions dealt only with security interests in personal property. Section 427 of the Bank Act does not deal with security interests in real property except insofar as personal property in which a security interest is claimed becomes affixed to real property. In that case, the Bank Act clarifies that appropriate registrations must be made in the applicable land registry office in order to preserve a priority interest.