Canada’s Highest Court holds unregistered PPSA security interest defeats subsequent Bank Act Security

What happens when two creditors with valid security interests, one taken by a financial institution pursuant to the federally enacted Bank Act, SC 1991, c 46 (“Bank Act”) and one by a credit union pursuant to a provincial personal property security regime, compete for priority over the same collateral? In a pair of recent decisions, the Supreme Court of Canada addressed this commonly arising conflict and held that an earlier Personal Property Security Act (“PPSA”) interest, even if unregistered and unperfected, takes priority over a subsequent Bank Act interest. As the Court’s decision also calls into question the efficacy of Bank Act security, banks should strongly consider registering their security under the relevant PPSA regime in order to ensure that their interest is afforded the priority expected and bargained for.  

the facts and judicial history

Bank of Montreal v Innovation Credit Union1 and Royal Bank of Canada v Radius Credit Union Ltd2 arose out of very similar fact patterns. In each case, a credit union (together, the “credit unions”) executed a general security agreement with a debtor (together, the “debtors”), governed by Saskatchewan’s PPSA, covering all present and after-acquired property. The debtors each subsequently turned to a financial institution (together, the “banks”) for additional financing and granted section 427 Bank Act security over much of the same collateral. Importantly, in both cases, the PPSA security interest was not registered or otherwise perfected until after the bank had already taken its security. Upon the debtors’ defaults, the banks seized and sold some of the collateral that was covered by both security interests. The credit unions each brought applications seeking a declaration that they had priority over the banks in the proceeds of the disposition.  

The application judge ruled in favour of the banks, holding that the Bank Act security took priority over the unregistered PPSA security. The Saskatchewan Court of Appeal unanimously overturned the lower court’s decisions, holding that in each case, the bank’s interest was subordinate to the interest of the credit union.3 The banks appealed.

the competing regimes

The source of conflict lies in the interaction of these two regimes, which have different historical origins and conceptual frameworks.  

The federal regime, governed by the Bank Act, dates back over a century and was intended to provide federally regulated banks a mechanism of providing loans secured by personal property, which had been previously prohibited, to promote granting credit to certain key sectors of the economy, such as farming, fishing and forestry. Importantly, the federal regime contains few provisions dealing with priority disputes over collateral, and little guidance as to how to resolve disputes with PPSA security interests. These disputes are generally resolved based on the applicable principles of property law.  

The modern provincial regimes, enacted more recently to simplify the law of secured lending in the provinces, consist of a codified framework specifically designed to resolve priority disputes through a detailed set of rules. The rules typically rely on when and whether security interests have attached (generally through the signing of a valid security agreement) and have been perfected (generally through registration) to determine priority. However, the Saskatchewan PPSA explicitly states that security interests governed by the Bank Act do not fall within the purview of the regime and, accordingly, these priority rules do not apply to Bank Act security.  

resolving priority disputes between Bank Act and PPSA security

the framework

The Supreme Court of Canada began by setting out the appropriate framework for resolving priority disputes of this nature.

The Court affirmed that since the provinces cannot enact law which affects valid federal legislation, the framework for resolving disputes between the two regimes is necessarily that supplied by the Bank Act. Therefore, if the Bank Act provides a specific provision that determines priority, then that provision will govern. If the Bank Act is silent on priority, the Court held that the first step in resolving the dispute is determining what proprietary rights were granted to the banks pursuant to the Bank Act. It is then necessary to determine what interest the debtor may have already conveyed to another creditor, and therefore what interest the debtor had left to convey to the banks. This second step requires an analysis of the nature of any security interest granted pursuant to the provincial regime. Therefore, while the internal priority rules of the PPSA are of no assistance in a dispute involving Bank Act security, the PPSA provisions that characterize the nature of a PPSA security interest still assist in determining the interests of the parties in a priority dispute.

application of the framework

Unsurprisingly, the Bank Act is silent as to the priority between a Bank Act security interest and a conflicting interest taken in the same property prior to the bank’s interest. It therefore became necessary for the Court to compare the nature of the proprietary interests granted under the competing regimes.

With respect to the federal regime, the Court parsed the language in sections 427(2) and 435(2) of the Bank Act to determine what proprietary interests had vested in the banks. The Court held that the combination of these two provisions effectively provided the banks with legal title to whatever rights the debtors held in the assigned collateral at the time the Bank Act security agreements were executed. However, they could not convey to the banks any greater interest than what the debtors themselves had left in the property at the time the Bank Act security was created.

In this regard, the Court then looked to the nature of the security interest that had already been granted to the credit unions. The Court ruled that the provincial security agreements constituted the creation of a fixed charge over the collateral that amounted to a legal proprietary interest in the property. Importantly, the fact that the collateral hadn’t been registered or otherwise perfected was not considered relevant to this characterization. The Court held that perfection affects only priority disputes governed by the PPSA regime and was not determinative of the nature or validity of the interest. The security agreement between the debtor and the credit union was sufficiently enforceable as against third parties.

Ultimately, the Court ruled that the banks could only take their interests subject to the prior PPSA security interests granted to the credit union, despite the fact that no search would have disclosed these security interests. The combined effect of the Bank Act provisions, along with the legal maxim nemo dat quod non habet (no one can give what he does not have), prevented the debtors from granting to the banks any interest that they had already granted to the credit unions. Significantly, the Court explicitly rejected the adoption of a first-to-register rule or a first-to-perfect rule to resolve a conflict between Bank Act and PPSA security, both which would have favoured the banks.

the after-acquired property twist

The Royal Bank of Canada case, which was ultimately decided along identical grounds, involved the added complication that the collateral at issue was only acquired by the debtor after both the credit union and the bank had taken their respective security interests. The Court of Appeal had held that this twist made a difference to its analysis because both interests had attached simultaneously when the collateral was purchased by the debtor.

The Supreme Court disagreed and held that the framework remained the same. Though the creditors’ respective interests might not attach until the property was purchased by the debtor, both parties had an inchoate proprietary interest in the after-acquired property from the moment their respective security agreements were executed. Therefore, pursuant to the analysis discussed above, the bank took its interest in the collateral subject to the credit union’s prior interest.

implications for lenders

In reaching its conclusions, the Supreme Court repeatedly recognized the widespread call for reform in this area, acknowledging the lack of a coherent interface between the “archaic concepts” of the Bank Act and the “modern principles” of the provincial regimes. In this regard, it noted that the “bank’s argument that this interpretation leads to commercially absurd results echoes the numerous cries for legislative reform and is not without merit.” While the guidance provided by the Supreme Court is of assistance, the Court itself recognized that the interpretive difficulties may not be entirely soluble without legislative action. The Court refused to judicially impose a first-to-register rule in the face of the current schemes, despite the legitimate policy arguments advanced by the banks. Legislative reform is needed to harmonize these regimes.

Unless and until such legislative reform takes shape, however, banks are best advised not to rely exclusively on Bank Act security because it could be defeated by a prior unregistered PPSA security interest that could not be discovered through searches in any public registry. Accordingly, banks should strongly consider registering their security under the relevant PPSA regime in order to ensure that their interest is afforded the priority expected and bargained for.