As the cross-border financing market begins to heat up after its long slumber, many U.S. and other foreign lenders are again making their way into the Canadian market place. In addition, as activity in the U.S. debt market returns, many Canadian companies are guaranteeing and providing security for their U.S. affiliates’ debt. While many seasoned U.S. lenders understand the importance of taking separate Canadian security, such a concept is still foreign to many. Many U.S. lenders would prefer that a Canadian debtor execute U.S. law governed security documents. While familiarity is a good reason to stick to tried and tested U.S. security documents, U.S. lenders need to understand that there are several reasons why Canadian law governed security is preferable. On a cross-border deal where U.S. security is being granted by U.S. credit parties, there’s no reason why the Canadian credit parties cannot also execute such documents. However, in such cases, Canadian law governed security should still be obtained.
First, Canadian conflict of laws rules often direct that the validity, perfection, effect of perfection or non-perfection of a security interest granted by a Canadian debtor will be governed by Canadian law. The choice of laws rules under Canadian law are more varied than the U.S. rules. For example, with respect to most tangible personal property, Ontario conflict of laws rules provide that the governing jurisdiction shall be the jurisdiction where the collateral is situate at the time that the security interest attaches. With respect to security interests in intangible property (such as accounts and intellectual property), Ontario conflicts of laws provide that the governing jurisdiction shall be the jurisdiction where the debtor is located at the time of attachment. If, for example, Ontario is the jurisdiction that governs the validity of a security interest, it makes sense that the security interest be governed by Ontario law. While U.S. law governed security documents may very well be sufficient to create a security interest under Ontario law, relying on U.S. law governed documents to achieve the desired legal consequence in Ontario is not without material risk.
Further, if the law governing the validity, perfection, effect of perfection and of non-perfection of a security interest is the law of a Canadian province, or if the debtor is incorporated in Canada or has a material presence in Canada, enforcement of the security interest and the assertion of the rights of the lender (either inside or outside of an insolvency proceeding) will necessarily be subject to the jurisdiction of Canadian courts. If such interest or rights are governed by U.S. law, U.S. law may need to be proved to the Canadian court before action may be taken (assuming, of course, that the Canadian court even agrees to apply U.S. law). In addition to the delay this will involve, the legal meaning and interpretation of a U.S. document will thus become subject to subjective interpretation of the Canadian court and the conflicting positions of the debtor and its counsel; that can never be a good thing from a lender’s perspective. Of course, using Canadian law governed documents also provides the intangible benefit of not inconveniencing the court with the need to apply law it is not qualified to understand in order to enforce or protect a lender’s rights or interests; that is always a good thing.