In 2006, Jonathan Fleisher wrote a guide for U.S. leasing professionals who are undertaking motor vehicle leasing in Canada. Since that date there have been a number of changes to the various aspects of Canadian law that changed certain fundamental matters. This article will restate the 2006 article and update where appropriate. This article, like the 2006 article, should be read in conjunction with prior articles Jonathan Fleisher has written on the leasing environment in Canada generally. These past articles discussed broad issues, such as withholding tax and regulatory concerns, but did not examine the specifics of any particular class of collateral or industry sector. It became apparent in 2006, a specific article regarding motor vehicles was required and that is the focus of this article. As will be noted below, there are significant differences in law and practice affecting Canadian and United States lessors and there also exists a general misunderstanding of the laws of Canada as they relate to motor vehicles. Unlike the 2006 article, there will also be a brief discussion on the changes to withholding tax and its impact generally. This article, while far from being a complete guide, will provide certain guidance as to the most significant concerns.
Background and Overview
The legal system in Canada, much like that of the United States, is a combination of federal and provincial law. The operation and sale of motor vehicles is a provincial, as opposed to federal matter. Similarly, registering security interests in Canada is governed by provincial law. Unlike the United States, a Uniform Commercial Code (“UCC”) has not been adopted. Instead, each province, except for Quebec, has enacted its own personal property regime known as the Personal Property Security Act (“PPSA”) which is substantially similar. Quebec, which has its own origin under French law, has adopted a civil code (much like Louisiana) and has significantly different procedures and policies than the other nine provinces. For this reason, any reference in this article to Canada will mean the nine provinces other than Quebec, often called the rest of Canada or ROC. Further, since most economic activity takes place in the province of Ontario, the focus of this article will be Ontario law. It should also be noted that while the PPSA is similar in the ROC, specific motor vehicle(s) regulations and highway traffic act laws can vary significantly from province to province. As mentioned above, Quebec has a separate and distinct legal structure and, as such, no comment will be provided on its particular issues and concerns except as otherwise stated.
This article will focus on four particular areas of interest to motor vehicle lessors. The first section will discuss recent changes to withholding tax. The second section will discuss the current law with respect to vicarious liability. Unlike the caution as set out above, this section will provide some guidance as to the law across Canada including Quebec. The third part of the article will discuss how to register a security interest in motor vehicles and appropriate titling law. Finally, the fourth part of this article will discuss particular regulatory requirements. This last section will deal strictly with Ontario.
Lastly, it should be noted that this article will deal strictly with commercial as opposed to consumer finance. Needless to say, there are significant rules in Canada with respect to consumer finance and consumer protection. As with the PPSA, each province has its own consumer protection code and again, while similar there are significant differences from province to province. The consumer protection legislation in most provinces sets out certain protections on behalf of lessees and certain disclosure requirements.
Regulatory Background and State of the Industry
Financial institutions are prohibited from leasing cars and trucks under 24 tonnes. Further, financial institutions that are regulated under the Bank Act are prohibited from taking a residual interest in any one lease in excess of 25% of the original equipment cost and 10% in its entire portfolio. It should also be noted that the prohibition is on leasing and not financing. A bank can provide financing for a commercial or consumer user to purchase a car based on a term note with a security interest in the car but cannot provide a nominal value lease. Accordingly, it is not uncommon to see banks holding a portfolio of motor vehicles in their overall structure.
Due to these restrictions, motor vehicle finance is fragmented. According to a recent Canadian Finance & Leasing Association (“CFLA”) study, 36% of the total number of equipment lessors are focused in the car market, with a total of $14.5 billion in new originations annually. Needless to say, this is an area where a smaller leasing company may be able to make its mark if it were able to provide a unique origination strategy. The prohibition on car leasing, does not extend to commercial finance companies that are not banks and as such, certain very large commercial finance companies are involved in this market, including GMAC Commercial Finance and Ford Credit Canada Limited. Further, while banks are not allowed to enter into relationships with consumers for motor vehicle leasing, they are allowed to finance leasing companies. Accordingly, it is not uncommon to see a relatively small Canadian lessor having a warehouse facility and a purchase facility with a schedule 1 or 2 bank.
1. Withholding Tax
Prior to January 1st, 2008, and subject to specific exceptions, any loan or lease between a U.S. lender and a Canadian borrower required the Canadian obligor to withhold a portion of the interest payment (in the case of a loan) or rental payment (in the case of a lease) and pay such amount to the Canadian taxing authorities. Commonly, the U.S. lender would require the Canadian borrower to “gross up” the payment to ensure the lender received the same money after tax. Needless to say, this generally made U.S. lenders less competitive than their Canadian counterparts. For this reason, many U.S. banks and commercial finance companies set up Canadian subsidiaries to allow them to undertake their transactions in a competitive environment. On January 1st, 2008, Canada amended its Income Tax Act (“ITA”) to eliminate the requirement for withholding on interest but not lease payments. For those who followed the implementation of this change, it was done in a rather convoluted and unexpected manner, so the various bulletins published on this matter may seem confusing. If one were to undertake a web search discussion, this issue and the materials will be far from clear. What is critical to understand is that the amendment did not change withholding tax on lease payments. It also did not change the Permanent Establishment (“PE”) rules. Generally, finance companies, banks and non-bankers avoided Canada not only for withholding tax issues but also so they would not become subject to what was perceived as oppressive Canadian taxes. If an entity had a PE in Canada, it would be subject to Canadian tax. The changes to the ITA did not change these PE rules.
The result of the changes then will be more limited than one might have thought at first blush. While a U.S. lender can now be competitive on loan transactions, it still must be careful not to have a PE in Canada. As having a sales force located in Canada would likely be indicative of a PE, the U.S. lender would not be able to market in Canada without risk. With that said, it does open up the opportunity for a U.S. lender who has no Canadian operations to finance the Canadian subsidiary of one of its existing U.S. clients. This should not be underestimated, as it may allow a U.S. lender to retain such client, as opposed to losing them to a multi-national lender or exposing them to a Canadian bank. For banks that already have existing Canadian subsidiaries, it is unlikely much will change as such banks will still run their Canadian business in Canada.
The ITA changes for the motor vehicle finance industry may be more profound as U.S. motor vehicle financiers tend to have clients who have operations in both countries and may have not been able to provide these clients with a financing solution. The change to the ITA may well change this and provide for a growth opportunity that may not have previously existed.
2. Vicarious Liability
One area in which Canada and the U.S differ greatly is in regard to vicarious liability. Unlike the U.S, it would be rare for a court in Canada to find a lessor vicariously liable for the acts of its lessee unless, it can be shown that there is some “special” connection between the lessor and the vendor of the equipment. Unfortunately, one area that does not have this special protection is that of motor vehicles which is what the balance of this section will focus on. In Canada, many of the provinces have enacted motor vehicle and highway traffic legislation, under which lessors and conditional sellers may be held vicariously liable. Attached to this article is a chart that summarizes the current state of vicarious liability in Canada.
Until recently, awards for personal injury and property damage tended to be relatively small. However, a recent settlement in Ontario caused this to change when a significant award of approximately $13 million was made against the lessor with respect to personal injuries suffered by a passenger in a motor vehicle accident. As these awards are quite rare, the leasing company did not have adequate insurance to protect against this loss. This caused an outcry amongst motor vehicle lessors in Ontario and ultimately resulted in a cap of $1 million being introduced in the province.
The general landscape in Canada, including Quebec, in regard to vicarious liability and personal injury, is that, a lessor will not be held liable for the personal injury suffered by an accident victim in all provinces except Alberta, British Columbia and Ontario. As noted above, liability in Ontario is limited to $1 million and this cap has recently been passed in British Columbia. By way of background, British Columbia had an exemption for vicarious liability but then in the landmark case of Yeung v. Au (2006) B.C. 975, the Court held that the exemption previously used by motor vehicle lessors could no longer be relied on. Under the British Columbia Motor Vehicle Act, a conditional seller is specifically exempted from liability. Case law, prior to the decision in the Yeung case found that a lessor would be treated in the same manner as a conditional seller. The Yeung case, however, reversed this decision and lessors are now liable. Needless to say, this development has been badly received by motor vehicle lessors in British Columbia and resulted in an intensive political pressure. British Columbia followed Ontario’s lead and introduced the cap on liability. Alberta being the only province in Canada remaining with full liability took steps in late 2007 to also introduce a cap. As of the writing of this article, the law had been passed by the Alberta parliament but not yet been proclaimed. It is anticipated to be in effect in the second or third quarter of 2008. As with Ontario, the limit will be $1 million.
Vicarious liability for lessors for motor vehicle property damage is much broader in that a lessor will be held liable for property damage in all provinces except for Prince Edward Island, Nova Scotia, New Brunswick and Newfoundland. This is subject to one caveat, namely, that it is not clear in the province of Saskatchewan whether a lessor would be liable for property damage as there is a some complexity within the meaning of “owner”.
In connection with conditional sale contracts, except for in Alberta and Ontario (where the legislation is unclear), all conditional sellers in Canada shall be exempt from vicarious liability. Due to this uncertainty, it may be preferable when transacting business in Ontario and Alberta to remove the title retention language in a conditional sales agreement so that the transaction would be determined to be a strict financing, as opposed to a conditional sale as it is clear in Canada that a lender with a security interest is not liable under any circumstance. Although the removal of the title retention language may cause the conditional seller to lose certain priorities it would otherwise obtain (such as a priority over landlord and certain government claims), it would ensure that there is no vicarious liability. This will be a business decision on a case by case basis.
The rule with respect to property damage for conditional sellers is the same as that with respect to leasing, except in the province of British Columbia where it is clear that there is no liability for property damage.
3. Registering Security
Unlike the United States, the appropriate mechanism for registering a security interest in a motor vehicle is to register the interest under the applicable PPSA by way of the filing of what is known as a “financing statement”. In all provinces, any lease (true or finance) in excess of 1 year, must be registered. It should be noted in Ontario this is a new change resulting from the introduction of Bill-152 which caused Ontario to be in conformity with all other provinces. Prior to Bill-152, Ontario had a concept of a lease introduced as a security but for a variety of reasons, this was changed.
The definition of “motor vehicle” for the purposes of the Ontario PPSA is:
(a) an automobile, motorcycle, motorized snow vehicle and any other vehicle that is self propelled, it does not include, a streetcar; (b) other vehicle running only upon rails; (c) a farm tractor; (d) an implement of husbandry; (e) a machine acquired for use or used as a road building machine; or (f) a craft intended primarily for use in the air or in or upon the water.
It should be noted that a lift truck is considered to be a motor vehicle, while a trailer is not. Other provinces have similar definitions, but if the vehicle is self propelled, then it would be prudent to review the applicable provincial legislation.
In order to properly register financing statements to protect a security interest in a motor vehicle, the Vehicle Identification Number (“VIN”) should be set out in the financing statement. While this is not strictly required for commercial motor vehicles, the failure to set out the VIN in the financing statement would result in the purchaser of a motor vehicle from a debtor being able to buy the motor vehicle free and clear of any all claims including those of secured parties. In other words, a secured party who did not set out the VIN in its financing statement would have priority over a trustee in bankruptcy and other registered secured parties, but would not have priority over a purchaser of the motor vehicle for value. Accordingly, the practical result is that in all cases, the VIN should be set out in the financing statement. As noted above, if trailers are being financed, there is no VIN and no requirement as such because they are not considered motor vehicles. Where the motor vehicle financing is for a consumer purpose, the VIN must be set out in all cases.
Under Ontario law, when a party is purchasing a motor vehicle, they must search against the VIN of the vehicle. There is no requirement to search against the secured party, only the VIN. If the VIN is not set out, then there will be no notice of the security interest and as a result, the party will take the vehicle free and clear. As with all property, there is no requirement to search if a sale is in the ordinary course of the vendor’s business.
One of the quirks of the Ontario PPSA is that it does not require a secured party to identify its specific collateral in the general collateral description box of the financing statement. The setting out of the VIN in the financing statement does not limit the security interest which a lessor may have in the properties and assets of a particular debtor. Where a VIN is indicated on the financing statement but no collateral description is set out in the general collateral description box, the registration will not provide adequate protection to third parties who are otherwise financing the debtor. Further, when Bill-152 was enacted amending the Ontario PPSA, it surprisingly changed a provision that allowed for a security party to set out a collateral description to limit the scope of its registration. Accordingly, in Ontario, if a purchase money security interest is not obtained, then waivers from private secured creditors should always be obtained. The other PPSA provinces have similar rules with respect to the registration of the VIN, but there is a specific requirement in each of these provinces to provide a general collateral description which unlike Ontario, can be relied upon.
The most significant distinction between the United States and Canada is that, in Canada, there is no requirement to have the motor vehicle titled or noted on the registration in the name of the lessor or conditional seller. While the noting on title may provide additional protection to the lessor or conditional seller under the concept of actual notice, it should be understood that this is not a legal requirement, even though it is common practice More importantly, the noting on title is not a substitute to registering under the applicable PPSA. If a party is merely noted on title and a registration is not effected under the PPSA, then the security interest as created under the finance contract would be ineffective as against a trustee in bankruptcy or other secured creditors. Accordingly, when leasing or conditionally selling motor vehicles in Canada, it is not permissible to rely on United States procedures and practices in order to protect a security interest. This point is being emphasized as it is the most common mistake made by foreign lessors/financiers when they initiate operations in Canada.
In order to be noted on title, a lessor must be a motor vehicle dealer.
4. Motor Vehicle Dealers Act
This section is limited to Ontario law. Motor vehicle dealers in Ontario are governed by the Motor Vehicle Dealers Act (“MVDA”). Except for certain exemptions, discussed below, no person can sell a motor vehicle unless they are a registered dealer. There is no direct statutory prohibition on leasing motor vehicles by non-registered dealers but an unregistered residual lessor is prohibited from selling the vehicle at the end of the term. While the MVDA is somewhat unclear as to which a party is caught by the sales prohibition and the circumstances under which it can and cannot sell a motor vehicle, it is clear that no new or used car sale can be made to the public unless the party selling is a registered dealer. Clearly, this is a form of consumer protection. The rules to become a dealer are discussed below.
There are several exemptions to the foregoing. Private sales are specifically exempted under the MVDA, pursuant to the regulations. Where the situation becomes more murky is in regard to a secured creditor. Under the regulations to the MVDA, there is an exemption for:
- an assignee, custodian, liquidator, receiver, trustee or other person acting under the Bankruptcy & Insolvency Act (Canada), the Business Corporations Act, the Courts of Justice Act, or the Winding-up Act (Canada) or a person acting under the order of any court or an executor or trustee who sells a motor vehicle in the course of the person’s duties; or
- a leasing company that is a subsidiary or an associate of a registered motor vehicle dealer, if the leasing company has filed with the Registrar a declaration that all lease-expired vehicles will be sold through the registered motor vehicle dealership and not offered to the public by the leasing company.
What is unclear is the exact meaning of “receiver” in the first case and “associate” in the second.
When the MVDA was enacted, “receiver” was not a defined term under the Bankruptcy & Insolvency Act (Canada). It now is and the definition includes a secured creditor acting on his/her own accord. The problem is the definition may not be broad enough to cover a secured creditor who only has an interest in a single vehicle of an otherwise large entity.
There is very limited case law to provide guidance on this point. In Re:731771 Ontario Ltd. et al v. The Queen in the Right of Ontario, the Ontario Court of Appeal considered whether banks and lending institutions selling vehicles to the public were motor vehicle dealers within the meaning of the MVDA. The Court, for other reasons, did not rule on this matter, but there was a rather well-reasoned dissent (which is obiter) by Abella J.A. which focuses on the definition of a motor vehicle dealer. Under Section 1(i) of the MVDA, a motor vehicle dealer is defined as a person who carries on “the business” of buying and selling motor vehicles. A bank is clearly in the business of banking and not “in the business of buying and selling vehicles” but only realizes on its security from time to time (and from a bank’s perspective, hopefully not that often). A bank is in the business of lending. Further, it is clear that the intent of Section 14(c) of the regulations (as set out above) contemplates bankers. Justice Abella J.A., in discussing whether banks realizing on security should be covered by the regulation comment saying:
“These are the classes of people, banks and financial institutions customarily rely on to assist them in realizing on their securities. There is no principled or logical justification for distinguishing banks and lending institutions from these classes of persons who are undertaking analogous transactions in an analogous capacity. It is illogical to declare that banks and lending institutions are carrying on business as “motor vehicle dealers”, but that the “agents” they routinely use to dispose of their vehicles are not.”
Since the case was overturned on other grounds, these rather helpful statements are not precedent but it is argued that they would be extremely persuasive if the issue were to arise.
This, however, does not assist a leasing company who is selling a vehicle at the end of the term of a lease. In these circumstances, the leasing company is not realizing on its security but is selling to the public. In this situation, a leasing company would have to rely on another exemption. If the leasing company can show it is “associated” with a dealer, then it may be able to rely on that exemption. The word associated is not defined in the Act and could have a variety of meanings. The most common is one of an ownership interest and in fact many leasing companies in Canada have cross-ownership with dealers. There are other meanings to the word including having a relationship with. In these cases, if it can be shown that the dealer and leasing company are acting in concert, then the exemption may be relied upon. From a policy perspective, which is to protect the public, it would seem that there would be little harm if a leasing company sold its residual interest through a registered dealer that it has a relationship with. That said, this is an argument and not a clear statement of the law. The better policy advice is to have the leasing company either be a dealer or have cross-ownership with a dealer. Returning to the registration issue, in order to be noted on title, a financier must become a motor vehicle dealer and obtain a registration identification number (“RIN”).
In order to become a dealer, the particular company must make an applicable filing with the Ministry of Consumer & Commercial Relations – Company Branch, provide a valid vendor permit under the Retail Sales Tax Act, and be registered to collect goods and services tax (“GST”) with the Canada Revenue Agency.
In addition and the most problematic concern, is that at least one senior employee of the company must be pre-screened by the Ontario Motor Vehicle Industry Counsel (“OMVIC”), which is a body created and self-regulated by motor vehicle dealers. The screening process is designed both to ensure good character and to have properly trained sales people. In order to obtain this designation, the employee must take a course put on by OMVIC which takes about 12 weeks. A leasing company cannot be a dealer overnight.
It should also be noted that there is a proposed New Motor Vehicle Dealers Act, 2002 (the “Act”). This Act while passed, has not yet come into effect. Under the new Act, a trade will include buying, selling, leasing… a motor vehicle. In June 2004, the Ministry of Consumer and Business Services released a draft of proposed regulations under the new Act to have 8 classes of motor vehicle dealers. One of these classes will be a lessor. It is not clear under this Act, whether a secured party who has a security interest over motor vehicles will be able to realize on its security. Further, the Ministry is still receiving comments from industry groups which may result in significant amendments to the Act and regulations. Currently, the government has not indicated any timetable when the regulation will be finalized or when the Act will come into force. Accordingly, the Act will not be summarized at this time.
In sum, the best advice for a leasing company is to become a registered dealer. If the leasing company is merely financing non-residual transactions, then it would be recommended that a note and security agreement structure be utilized. This would exempt the finance company from vicarious liability, allow for proper registration of a security interest under the PPSA and finally, eliminate the requirement to become a registered dealer if they are required to dispose of their vehicles.