This article was authored with the assistance of Jean-Loup Lalonde, a student in the Gowling WLG Montreal office.
Mergers and acquisitions are more and more frequent in our globalized, modern and fast-paced economy. According to statistics provided by The Institute for Mergers, Acquisitions and Alliances (IMAA), 129 mergers and acquisitions were announced in Canada in 1985. In 2013, that number had risen to 2,303, a more than 17-fold increase. And in 2017, it reached a record-setting 3,512 transactions. While mergers are a symptom of a healthy economy, they do carry risks for secured parties and hypothecary creditors. Recently we studied the following situation.
Company A, in order to finance its growth, reaches an agreement with Bank A for new financing. To secure its present and future obligations to Bank A, Company A grants to Bank A a first-ranking security in the form of a movable hypothec on all its current and future movable property which is registered on December 1, 2017 (the “Bank A Security”). Bank A is, therefore, a secured party and its risk exposure is reduced.
Simultaneously, Company B reaches an agreement with Bank B under conditions similar to those of Company A and Bank A. According to the agreements entered between Company B and Bank B, Bank B is a secured party benefiting from a movable hypothec on all of Company B’s current and future movable property registered on December 31, 2018 (the “Bank B Security”).
Subsequently, Company A and Company B merge to become Company C. Regarding the obligations of Company C in respect of Company A and Company B’s obligations existing prior to the merger, the rights of both Bank A and Bank B are not affected by the merger. Both the Canadian Business Corporation Act and the Quebec Business Corporation Act provide that the obligations of the amalgamating corporations (Company A and B) become the obligations of the amalgamated corporation (Company C).
However, the merger may result in the following scenario from a publication (perfection) point of view. If Company C defaulted in its obligations to either bank, or was petitioned into bankruptcy, which of Bank A and Bank B, would have first-ranking rights as a secured party? Furthermore, over what property would those rights apply?
3. Case Law
There are very few decisions rendered by the courts on this issue, but two leading decisions of the Quebec Court of Appeal do address the question. Both decisions reinforce that a secured party should make sure its loan documentation provides adequate language so that a debtor may not merge or amalgamate without the secured party’s prior consent.
Firstly, in 1989, the Quebec Court of Appeal rendered its decisions in Trust Général du Canada c. Compagnie du Trust National ltée. In this case, a hypothec was registered in 1978 in favour of Trust Général du Canada (“Trust General”) over all present and future property of Maislin Realties Ltd. (“MR”). Compagnie du Trust National ltée (“Trust National”), in parallel, was granted a movable hypothec on present and future property of Maislin Transport Ltd. (“MT”), which was registered two years later, in 1980. In late 1980, MR and MT merged to form a single company (the “AmalCo”).
Upon default by AmalCo, Trust National, invoking its 1980 hypothec, took possession of some of the AmalCo’s movable property and sold it. Prior to the merger, the property sold was owned by MT, and was charged by a first-ranking hypothec in favour of Trust National.
Trust Général asked the courts to determine the respective rights of the two secured parties. Trust Général argued that Trust National had no rights over the property it had seized and sold, because its hypothec was registered two years after Trust Général’s hypothec. Trust Général maintained that following the merger the property of MT and MR had become consolidated. Therefore, only the hypothec's date of registration would determine first-ranking priority over AmalCo’s property, and it was irrelevant that the property seized was originally owned by MT, Trust National’s debtor.
The Court of Appeal did not accept Trust Général’s argument. In its unanimous ruling, the Court stated that Trust National acted within its rights. Despite having registered its hypothec after that of Trust Général, Trust National had first-ranking priority over the property seized. The Court explained that the property seized was acquired before the merger by a company over which Trust National had a first-ranking hypothec. Moreover, the constitutive act of Trust Général’s hypothec could not charge goods that originated from a company over which it had no security.
The Court of Appeal recognized that, in a case like this, where the disputed goods were acquired before the merger, the decisive factor determining first-raking priority was not the date of registration of the hypothec, but rather the origination of the goods, which create a “lien” between them and the secured party. It is important to note that this logic may only apply to identifiable goods.
More than a decade later, in 2000, the Quebec Court of Appeal issued a second ruling on this issue in Banque Royale du Canada c. Banque canadienne impériale de commerce. In this case, the facts differed from those that led to the Trust Général ruling, as it concerned property acquired after the amalgamation. According to the Court, an amalgamation does not result in the merging entities being terminated. Rather, the merging entities continue to exist in a new form; that of a single amalgamated entity, which carries every security previously held by its “founding” entities. Therefore, following a merger, the secured parties were entitled to security over all the assets of the AmalCo, with first-ranking priority determined by the date of registration.
In this second instance, the Court of Appeal recognized and applied the principle of first registration in order to establish first-ranking priority. The decisive factor, which allowed the Court to distinguish this case from Trust Général, was that the disputed property was acquired after the amalgamation. Consequently, there was no “lien” held by the secured creditors on pre-merger specific goods, which would have needed to be kept “unimpaired” by the merger.
It might be impossible for secured creditors to anticipate and mitigate every risk. However, keeping in mind the potential consequences of a merger can help to reduce risk, especially in an economy in which mergers are frequent. Using adequate language in the loan documentation, including the agreement creating a hypothec and the offer of financing for instance, should not be neglected. However, even though such language is included in the loan documentation, if a merger not consented to by the secured party occurs, the rights of the secured party are limited to demanding the immediate payment of all outstanding amounts and penalties if applicable.
The previous rulings by the Court of Appeal teach us that, in order to determine first-ranking priority, and therefore assess the risk arising from an amalgamation, it is essential to consider the date of acquisition of the property (before or after the amalgamation), which will decide if the first registration rule or the “unimpaired lien” will prevail.