In the early nineties, Quebec adopted new personal property legislation under the reform of the Civil Code of Quebec (the "CCQ"). However, the CCQ incorporated language and legislation from Quebec's former personal property regime. This combination of old and new legislation has, in some cases, left remnants of formalism surrounding the creation of certain types of hypothecs (security interests). In Positron Technologies Inc. (Arrangement de) 500-11-031970-078, the Quebec Superior court recently ruled on one such situation dealing with the enforceability of a hypothec given to secure a debenture.
The Quebec Superior Court decision is of particular importance to debenture holders. The decision clarifies the requirements of a hypothec given to secure a debenture set out in Article 2692 of the CCQ ("Article 2692 CCQ"). In doing so, the Court may have rendered existing security granted under such debentures unenforceable. While an appeal from this judgment may be filed, it may be advisable to review past transactions involving debentures secured by Quebec hypothecs to determine whether remedial measures are warranted.
The Quebec Superior court held that a hypothec created to secure a debenture was unenforceable as it had not been constituted in accordance with the requirements of Article 2692 CCQ. In other words, it was not (a) created in favour of a person holding a power of attorney for creditors (in essence, a security trustee) and (b) notarized.
By way of background, Article 2692 CCQ provides that:
A hypothec securing payment of bonds or other titles of indebtedness issued by a trustee, a limited partnership or a legal person authorized to do so by law shall, on pain of absolute nullity, be granted by notarial act en minute in favour of the person holding the power of attorney of the creditors. (emphasis added)
On November 28, 2007, an initial order was issued with respect to Positron Technologies Inc. ("PTI") under the Companies' Creditors Arrangement Act (Canada) (the "CCAA"). Under this order RSM Richter (the "Monitor") was appointed as monitor.
On December 10, 2007, PTI was authorized to sell its assets and its business to Triton Électronique Inc. ("TEI") and allowed PTI to distribute the proceeds from such sale to its secured creditors, namely Quorum Investment Pool Limited Partnership ("Quorum").
Further to the December 10, 2007 order, the Monitor requested from the secured creditors that they produce the documents evidencing their security.
On December 12, 2007, Quorum submitted the following:
- Two (2) debentures to the Monitor: (a) Convertible Debenture #1 issued on June 2, 2005 by PTI in favour of Quorum in the amount of $2 million bearing interest at the rate of 7% per annum ("Debenture #1") and (b) Convertible Debenture #2 issued on April 30, 2007 by PTI in favour of Quorum in the amount of $1 million bearing interest at the rate of 9% ("Debenture #2").
- Two (2) movable hypothecs without delivery: (a) one hypothec constituted under private writing (i.e. mere signature as opposed to a notarial act) to secure Debenture #1 published at the Register of Personal and Movable Real Rights (the "RPMRR") on May 31, 2005 ("Hypothec #1") and (b) one hypothec constituted by notarial act to secure Debenture #2 published at the RPMRR on April 25, 2007 ("Hypothec #2").
The Monitor considered Hypothec #1 to be invalid, as it had not been constituted (a) by notarial act, nor (b) in favour of a person holding power of attorney for the creditors, as prescribed in Article 2692 CCQ.
Quorum relied on an interpretation based on the historical context of Article 2692 CCQ in order to argue that the Article should not apply to Hypothec #1. Quorum submitted that Article 2692 CCQ was based on provisions of the Special Corporate Powers Act (the "SPCA"). These sections of the SPCA were necessary prior to the CCQ to allow an entity to benefit from certain types of security interests, including security interests over personal property as this type of security could only be granted in a handful of situations. Since the new CCQ provides for less restrictive rules regarding the creation of movable hypothecs, Quorum argued its creation of a hypothec, even if it guarantees obligations under a debenture, should not be subject to the formalism prescribed in Article 2692 CCQ.
The court rejected Quorum's arguments. The court established the following three (3) basic elements that, if present, render Article 2692 CCQ applicable:
- a movable hypothec,
- that guarantees bonds or other title of indebtedness,
- that are issued by a trustee, a limited partnership or a legal person authorized to do so by law.
The Court held that each of these elements were present in the case of Hypothec #1.
The Court further established that once these elements are present, Article 2692 CCQ requires a) a hypothec by notarial act en minute and b) that it be granted in favour of a person holding a power of attorney for the creditors, even if there is only one creditor.
Consequently, because Hypothec #1 did not meet these requirements it was not enforceable.
This decision has serious implications for debenture holders whose debenture is secured by way of hypothec. As of late, some practitioners no longer bothered with the formalities of Article 2692 CCQ when dealing with a debenture in favour of a single creditor. The decision will force them to review their practices.
It should be noted that loans evidenced by simple credit agreements are not subject to Article 2692 CCQ. Furthermore, the unenforceability of a hypothec does not taint the enforceability of the underlying debenture. However, it may pose a serious risk if debenture holders ever want to realize on the debtor's collateral.
To ensure the enforceability of their security in Quebec, debenture holders should carefully review any hypothec securing their debentures to ensure the hypothec has been properly constituted.
If Article 2692 CCQ is applicable but the requirements have not been met, debenture holders should take the following steps:
- Appoint a person holding power of attorney on behalf of the debenture holder as "holder" of the hypothec; and
- Re-execute the hypothec before a notary.
If a hypothec needs to be rexecuted, it will also need to be published (i.e. registered) again at the RPMRR. Consequently, waivers or subordination may need to be obtained to deal with intervening registrations.
Please note that this decision emanates from the Quebec Superior Court and is subject to appeal. We will keep you appraised of any further developments.