The issue of whether an unsecured party can purchase a secured party’s debt to shelter its own unsecured debt under the newly acquired security is often debated. To date, there has been little Canadian jurisprudence addressing this practice. The recent case of CPC Networks Corp. v. Eagle Eye Investments Inc.1 confirms that the practice does not work.
Security agreements often contain “all obligations” clauses which secure all of a debtor’s present and future obligations owed to a secured creditor. Occasionally, all obligations clauses have been used in an attempt to convert unsecured debt to secured debt by either (a) assigning the security agreement to an unsecured creditor or (b) assigning unsecured claims to a secured creditor. These situations have been considered by courts in England, Australia, New Zealand and the United States, but Canadian case law on this issue has been very limited.
In Eagle Eye, an unsecured creditor obtained an assignment of a secured creditor’s debt and related security. The unsecured creditor then claimed that its pre-existing unsecured debt was transformed into secured debt as a result of the all obligations clause contained in the assigned security.
The unsecured creditor took the position that since the assigned security covered all present and after-acquired liabilities of the debtor to the original creditor, and since the unsecured creditor had stepped into the shoes of the original creditor by virtue of the assignment of the debt and related security, all debts owed by the debtor to the unsecured creditor, including the prior unsecured loan, were secured by the assigned security.
The debtor argued that the actions of the unsecured creditor were contrary to section 65 of the Personal Property Security Act (Saskatchewan) (the “PPSA”) which requires that parties to a security agreement act in good faith and in a commercially reasonable manner. Furthermore, the debtor submitted that the terms of the assigned security were subject to the terms of the assigned debt documents which did not contemplate the prior unsecured loan between the unsecured creditor and the debtor.
The court held in favour of the debtor, agreeing that the assigned security did not extend to the prior unsecured loan between the unsecured creditor and the debtor. Without providing an indication of which reasons were primarily relied upon, the court provided the following reasons for its decision:
- the assignment of the debt and related security was not done in good faith or a commercially reasonable manner;
- the all obligations clause should be read literally so as to limit it to indebtedness between the original parties;
- it would be inequitable to allow an unsecured claim to jump the priority queue by obtaining an assignment of a higher priority claim;
- a broad interpretation of the all obligations clause would be unfair to the debtor since the debtor would not normally anticipate that an all obligations clause would be used by an unsecured creditor to transform itself into a secured creditor by obtaining an assignment of a security agreement;
- allowing an unsecured creditor to convert its unsecured claim into a secured claim by obtaining an assignment of a security agreement would have a destructive impact on the principle of pro rata sharing in bankruptcy law; and
- a broad interpretation of the all obligations clause would compromise the predictability, reliability and integrity of the PPSA priority structure.
While we are uncertain whether another court would accept all of the reasons set out above in making a similar determination, this case is instructive as to the concerns that may be raised.