On November 5, 2010, the Supreme Court of Canada gave judgment in two companion cases involving security granted under section 427 of the Bank Act (Canada) (the “Bank Act Security”) in competition with security granted under the Personal Property Security Act (Saskatchewan) (the “PPSA”). The two cases, Bank of Montreal v. Innovation Credit Union1 and Royal Bank of Canada v. Radius Credit Union Ltd.2, gave the Court an opportunity to bring some clarity to what had become, in the Court’s words, “a muddled area of law”3.
In both Innovation and Radius, a debtor had executed a general security agreement (“GSA”) under the PPSA in favour of a credit union, prior to granting Bank Act Security in the same collateral to the bank. In each case the credit union had not registered notice of its interest in the Personal Property Registry, and the debtor had not disclosed the pre‐existing GSA at the time that the bank took and registered Bank Act Security.
Upon the default of each debtor, it fell to be determined whether the unperfected security interests under the PPSA had priority over the valid Bank Act Security taken later. The Court found, in both cases, that it did.
The security regimes under the Bank Act and under the PPSA are entirely separate. The Bank Act does not address the interplay of Bank Act Security with other security regimes; the PPSA expressly excludes Bank Act Security from the scope of its application. In Saskatchewan, the PPSA presents an additional hurdle to banks – if a debtor grants Bank Act Security, any security granted under the PPSA to the same secured party in the same collateral is rendered void. Because of this, these cases will have less practical impact in other provinces where banks tend to obtain general security agreements and file financing statements under the PPSA (whether or not they also obtain Bank Act Security).
The Court, in both cases, recognized the paramountcy of federal legislation. However, since Parliament had failed to legislate in the area of competing federal and provincial security regimes, the Court was obliged to resort to the common law, tempered by the provincial modifications to personal property law, to resolve the priority dispute.
In Innovation, the Court stated, “While the provinces cannot legislate in order to oust the bank’s rights, they can alter the law as it relates to property and civil rights in the province.”4 The Court found that a valid security interest in favour of the credit union had been created when the debtor signed its GSA. The Court upheld earlier decisions and academic commentary to conclude that the credit union’s PPSA interest constituted a fixed charge on the collateral, in the nature of a proprietary interest. The Court held that perfection by registration under the PPSA is only relevant in establishing priority between competing PPSA security interests, and as such could have no bearing on a question of priority between a PPSA security interest and a Bank Act interest. Furthermore, perfection or lack of perfection under the PPSA did not affect the nature or validity of the credit union’s security interest, which arose upon signing the GSA.
With these findings in mind, the Court applied the common law principle nemo dat quod non habet (loosely translated, a debtor cannot give rights in collateral that it does not have, or that it has already transferred to another secured party). As the debtor had granted a proprietary interest in the collateral to the credit union when the GSA was signed, the bank could only take an interest in the debtor’s equitable right of redemption in the collateral. The credit union’s unregistered and undisclosed security interest therefore took priority.
Radius presented essentially the same facts but with a twist – the collateral in question was acquired after both the GSA and the Bank Act Security had been granted. The question of when the proprietary interest under the PPSA arose was therefore central to the determination of priority. The Saskatchewan Court of Appeal had resolved the issue in favour of the credit union by applying the principle “first in time is first in right”. However, the Supreme Court of Canada, coming to the same conclusion, stated that the applicable principle was not “first in time” but “nemo dat”, as discussed above. Despite the fact that under the PPSA a security interest in after‐acquired collateral attaches when the debtor acquires rights in that collateral, the Court found that, for the purposes of a nemo dat analysis, the relevant date was the date the GSA was signed, as that was the date on which a proprietary interest was conferred upon the credit union.
It should be noted that the trial judge in Innovation had held in favour of the bank on the basis of the priority rule set out in section 428 of the Bank Act, which states that security under section 427 has priority “over all rights subsequently acquired in or in respect of that property”. The trial judge reasoned that section 428 extended to subsequently‐acquired priority rights. As the credit union’s priority rights arose under the PPSA when it registered in the Personal Property Registry, after the Bank Act Security had been taken, the bank had priority. The Supreme Court of Canada, before explaining why this interpretation was incorrect, made the following comment regarding the trial judge’s analysis:
“In addition to its being a reasonable interpretation of the text of the Bank Act, Zarzeczny J. viewed this interpretation as best promoting two policy goals reflected in the Act. First, it provides a means of achieving compatibility and resolving future conflicts between the PPSA and the Bank Act. Second, it promotes commercial and business lending efficacy and predictability.”5
Both banks in these cases submitted that the application of the nemo dat rule would lead to a commercially unreasonable result and advocated for the adoption by the Court of a “first to register” priority rule. The Court in both cases could find no legislative basis on which to do so. In Radius, the Court noted that, “Such a rule would have to be enacted by Parliament, if it saw fit to do so.”6 In Innovation, the Court stated, “The Bank’s argument echoes the cry by many commentators for legislative reform.”7
It seems clear that the Court did not relish making these findings and joined, more or less subtly, in the cry for legislative reform. One such cry was contained in an October 2004 report to Parliament8 on the topic of Bank Act security, which identified several areas of concern and concluded with a recommendation that sections 427 to 429 of the Bank Act be repealed.
However, neither legislative reform nor repeal of those sections appears to be high on Parliament’s legislative agenda. In the meantime, banks who wish to take security under the Bank Act would be well advised to take additional security under provincial personal property security legislation where the two may coexist. Banks lending to debtors in Saskatchewan will need to assess the value of Bank Act security and consider whether security under the PPSA would afford better protection.