The federal government has recently introduced Bill S-5 (Financial System Review Act) to address the issue of priority as between registered security taken pursuant to Section 427 of the Bank Act and an unregistered (unperfected) security interest taken pursuant to the provisions of the provincial personal property security statutes across Canada. The proposed amendments to Sections 425, 426 and 428 of the Bank Act contained in Bill S-5 have been drafted to reverse the effects of the Supreme Court of Canada’s decisions in Bank of Montreal v. Innovation Credit Union (“Innovation”) and Royal Bank of Canada v. Radius Credit Union Ltd. (“Radius”).

As reported in our December 2010 issue, the Supreme Court ruled in the Innovation and Radius cases that an unregistered security interest granted to a credit union by way of a general security agreement had priority over subsequent, but registered, Bank Act security granted to a bank. The Supreme Court concluded that the common law principles of: (1) “first in time” vis-à-vis the granting of the security, and (2) “nemo dat quod non habet” (or, “no one gives what they do not have”) must prevail where no statutory priority provision applies. In each case, because the debtor had already granted a security interest in all of its present and after-acquired personal property to the credit union, it could not subsequently transfer an unencumbered interest in those assets to the bank. In other words, the debtor could not transfer to the bank a greater interest in its property than the debtor itself possessed at that time.

When amended, Subsections 426(7) and 428(1) of the Bank Act will provide that the rights of a bank in respect of property subject to security taken and registered under the Bank Act will have priority over the rights of “any person who had a security interest in that property that was unperfected at the time the bank acquired its security in the property”.  Subsection 425(1) of the Bank Act will also be amended to add a broad definition of the term “unperfected” which, in relation to a security interest, will refer to a security interest that has not been registered or publicized to third parties under the law under which the security interest was created.

One note of caution is that other proposed amendments to Subsections 426(7.1) and 428(2) of the Bank Act introduce important knowledge qualifiers that constitute exceptions to the newly established priority rule. The Bill’s new priority rule will not give a bank priority over an unperfected personal property security interest if, at the time the bank acquired its security in the property, the bank did so with knowledge of that other security interest. The term “knowledge” has not been defined in the proposed amendments and, as such, there will be some uncertainty as to what constitutes knowledge.  Will, for example, verbal communication of the existence of another creditor be sufficient to trigger the knowledge exception?  In addition to muddying the waters with a knowledge limitation, Bill S-5 stops short of expressly codifying any priority rule as between a registered personal property security interest and registered Bank Act security interest, which is presumably that the first registered security interest (in time) would prevail.

Despite the introduction of Bill S-5, banks should not take Bank Act security in isolation in reliance upon the Bill’s provisions.  Where possible, Bank Act security should be paired with a general security agreement with appropriate PPSA registrations made in all applicable provinces in order to defeat any unregistered PPSA interests that may exist.

Bill S-5 passed third reading in the Senate on December 16, 2011 and, on second reading in the House of Commons on February 14, 2012, was referred to the Standing Committee on Finance.  The Standing Committee reported back on March 16, 2012 without proposing any amendments  to the Bill.  It is expected to soon receive third reading in the House of Commons.