The global COVID-19 pandemic continues to shake the North American marketplace. While we are months away from understanding the full impact of the pandemic, it is increasingly likely that businesses will be under severe distress as they face supply chain interruptions, workforce challenges, decreased consumer spending and travel restrictions.  In this uncertain economic environment, lenders should be proactively assessing their exposure from loan portfolios and reviewing their collateral positions to ensure that they are in the best position to react quickly to borrower challenges.  In particular, it is recommended that lenders review and confirm that any security taken to support their loans remains valid and effective.

To that end, lenders that have borrowers in both the United States and Canada, should be aware of the differences between the personal property security regimes in these two countries. In the United States, Article 9 (“Article 9”) of the Uniform Commercial Code (“UCC”) governs secured transactions while the equivalent regime in the common law provinces of Canada is the Personal Property Security Act (Ontario) (“PPSA”) or equivalent legislation in each other common law province.  In Quebec, the creation and enforcement of security on movable (personal) and immovable (real) property is governed by the Civil Code of Quebec. The PPSA and UCC regimes are largely similar as the PPSA is based on the UCC.  Although the Civil Code of Quebec is based on a European-styled civil code model, it provides for substantially similar protections for secured lenders to those found under the PPSA.  However, there are key differences lenders should be aware of when considering their security interests under all Canadian jurisdictions.

This article will seek to highlight some of the key differences between the Canadian and UCC regimes that creditors should be aware of when obtaining, maintaining and enforcing security. While the main focus will be on differences between the PPSA and the UCC, special mention will be made of the Civil Code of Quebec to highlight key differences. 

Security Interests Generally

In order to have a valid security interest, there must be attachment and perfection. Attachment generally occurs when funds are advanced to a creditor pursuant to a financing agreement. This is the same under both regimes. In Canada, in order to perfect a security interest, you must “register” that interest in the PPSA registry. To do so, the secured creditor must file a financing statement. This financing statement contains information about the parties as well as the security agreement and general information about the collateral. Under the UCC, “filing” a financing statement can be used to perfect a security interest. This process is similar to registering an interest under the PPSA. However, as will be discussed below, security interests in some types of collateral can be perfected by “control”. The PPSA and Article 9 of the UCC apply only to personal property and are inapplicable to real property. 

Taking Security in Quebec

In Quebec, the creation and enforcement of security rights is governed by the Civil Code of Quebec. The hypothec is a type of security interest that can be granted to secure an interest in personal property. It is generally required that a hypothec be published (similar to registration) in the Quebec Register of Personal and Movable Real Rights (“RPMRR”) in order to enforce the rights against third parties. 

Priority

Both the U.S. and Canadian regimes are similar in that a lender must have a perfected security interest in order to be able to claim that security interest. Where there are multiple security interests registered in respect of the same collateral, the secured lender with priority will be able to enforce on the collateral. Priority is generally given to the party that has registered their interest first. This principle is the same under the UCC, the PPSA and the Civil Code of Quebec. However, as will be discussed in detail below, a lender that has perfected by control will have priority over a previously filed security agreement.

There are also certain forms of interests that will have priority even if not registered first. Under the PPSA, a Purchase Money Security Interest (PMSI) ranks ahead of all other security interests.¹ A PMSI is created where a lender advances funds to purchase a specific asset, and therefore grants that lender “super-priority” in that specific asset. The concept of a PMSI is also found in the UCC which gives creditors priority over competing interests.² However, no such concept is found in the Civil Code of Quebec.

Perfection by Control – Investment Securities and Bank Accounts

Similar to UCC Article 8, under the PPSA and the Securities Transfer Act, 2006 (“STA”), versions of which are in force in all Canadian PPSA jurisdictions (harmonised legislation is in force in Quebec), a secured party can perfect its security interest in investment securities or shares by registering under the PPSA or by taking control under the STA (or both).  An interest perfected by control has priority over one perfected only by registration or simple delivery of the unendorsed share certificates.

One key difference between the UCC and the PPSA is how the regimes treat security interests in bank accounts. The concept of perfection by control is present in the UCC while not in the Canadian regime (with the exception of Quebec). Under Article 9 of the UCC, a security interest in a commercial deposit account may be perfected by control. 

Under the Civil Code of Quebec, it is possible to perfect hypothecs over cash deposits in bank accounts (referred to as monetary claims) by “control”, in a manner very similar to Article 9.  Where the creditor is also the account bank, the creditor obtains control by the debtor (i.e., the account holder) consenting to such monetary claims securing performance of its obligations to the creditor.  Where the creditor is not the account bank, the creditor obtains control by either: (i) entering into a control agreement with the account bank and the debtor, pursuant to which the account bank agrees to comply with the creditor’s instructions, without the additional consent of the debtor; or (ii) becoming the account holder.

The PPSA does not have the same concept of perfection by control for cash deposits. The only way creditors can take a security interest in cash deposits is through registration of the interest. This is considered to be less advantageous than perfection by control as the secured party will have less certainty with respect to the ability to enforce their security. This is because other secured lenders may be able to assert that they have greater priority over the interest in the cash deposits. 

Notice Periods

One difference that secured parties should be aware of is the different notice periods required under the PPSA and the UCC for enforcing a security agreement should a party default on its obligations under a financing agreement. Under the PPSA, when a party has defaulted on its obligations, the secured party may dispose of the collateral in order to satisfy their debt.³ The PPSA requires that the secured party give not less than fifteen days notice in writing before the collateral is disposed of.⁴ Under the UCC, reasonable notice is required before collateral can be disposed of.⁵ For consumer transactions, reasonable notice is a question of fact.⁶ For commercial transactions, reasonable notice is deemed to be ten days.⁷ Lenders should be aware of these notice requirements before enforcing on their security.

In addition to the applicable PPSA notice periods, lenders seeking to enforce security in Canada should be aware of the separate notice requirements imposed on secured creditors under Canada’s federal bankruptcy regime.  Under section 244 of the Bankruptcy and Insolvency Act (Canada) (“BIA”), secured creditors must, in specific circumstances, deliver a 10-day notice of intention to enforce security (a “244 Notice”) (in a statutorily prescribed form).⁸  A 244 Notice is required in circumstances where the secured creditor intends to enforce on all or substantially all of the borrower’s inventory, accounts receivable, or other property that was acquired for, or used in, the borrower’s business.⁹ In addition, the borrower must be an “insolvent person” as that term is defined in the BIA.¹⁰ 

Applicable Regime

As noted above, each state or province has its own legislation. Therefore, creditors should take note of which regime applies and the differences between those regimes.  For tangible assets, the rule in the PPSA is that the legislation of the province where the asset is located will apply.¹¹ However, under the UCC, the laws of the location of the debtor will apply to tangible assets.¹²  For intangible assets, the applicable regime is based on the location of the debtor.  Except in Ontario and British Columbia, a debtor with multiple places of business is deemed to be located at its “chief executive office”.  Under amendments to Ontario’s PPSA that came into force on December 31, 2015 and amendments to British Columbia’s PPSA that came into force on June 1, 2019, most debtors are deemed to be located in the jurisdictions in which they were incorporated or organised, similar to the more generally applicable debtor location rules under Article 9 of the UCC.  In Quebec, for tangible property, the regime where the property is located would apply. For tangible property, it is the location of the debtor that is relevant.

Validity of Financing Statement

In Canada, the length of validity of a financing statement and RPMRR registration in Quebec is variable. A secured creditor can elect the registration period of their choice at the time of registration. A perpetual registration is also available. In Canadian transactions, it is quite common to register for a period of time that exceeds the current maturity date plus a reasonable cushion of years to account for renewals and amendments based on agreement of the parties and to avoid a lapse in perfection. Under the UCC, the length of registration of a security interest is generally five years.¹³ Creditors should be aware of these differences and ensure that they diarize any variations of the renewal/expiry dates, in particular for transactions where both Canadian and UCC filings are in place, to avoid confusion.

Insolvency & Restructuring

Insolvency law in Canada is governed by two main federal statutes, the Bankruptcy and Insolvency Act (the “BIA”) and the Companies’ Creditors Arrangement Act (the “CCAA”).  The latter functions for mid-size and larger cases as Canada’s primary equivalent of Chapter 11 of the United States Bankruptcy Code, while the former contains both an equivalent to Chapter 7 and an abbreviated, simplified restructuring scheme used primarily in smaller cases. Insolvency proceedings under either statute will allow for a stay of proceedings against the company.

BIA liquidation proceedings can take two forms, a bankruptcy proceeding (typically an unsecured creditor remedy) or a court-appointed receivership (typically a secured creditor remedy). In a bankruptcy proceeding, the stay of proceedings would not prevent a secured creditor from realizing on its collateral. However, if there is a court-appointed receivership, the order generally contains language which stays the actions of secured creditors. If a debtor commences a simplified restructuring proceeding by filing a notice of intention (NOI) to make a proposal under the BIA, a secured creditor’s right will automatically be stayed unless certain conditions are met. These include the secured creditor taking possession of the property before the filing, the secured creditor delivering a 244 notice (discussed above) to the debtor more than 10 days prior to the filing of the NOI or the debtor providing consent to enforcement of secured creditor rights. 

In proceedings commenced under the CCAA, secured creditors are generally prohibited from enforcing their security interests during the proceeding. While the CCAA contains many of the same types of relief available under Chapter 11, there are some differences of which secured creditors should take note.  Specifically, Canadian bankruptcy law does not have a concept of “adequate protection” for pre-filing secured creditors whose collateral is being primed.  In addition, debtors are not required to obtain specific permission to continue to use cash (which may form part of a secured creditor’s collateral) during the proceeding. 

Conclusion

In uncertain and financially unstable times, lenders may be looking to review and verify security arrangements to ensure they are properly protected and perfected in any downside scenario, and, in the worst case, prepared to take enforcement actions on short notice. While the regimes in Canada and the United States share many similarities, there are important differences lenders should be aware of when reviewing or putting in place new loans and security or considering enforcing on their security. Proactive steps taken by lenders to re-familiarize themselves with the differences between security regimes when reviewing loan portfolios and collateral documents will help to avoid unnecessary surprises when it comes time to enforce security.   

¹  Personal Property Security Act, RSO 1990, c P10, s 33.
²  UCC § 9-103.
³  Supra note 1 at s 63(1).
⁴  Ibid at 63(4).
⁵  Supra note 2 at § 9-611.
⁶  Ibid at § 9-612.
⁷  Ibid.
⁸  Bankruptcy and Insolvency Act, RSC 1985, c B-3, s. 244.
⁹  Ibid.
¹⁰ Ibid. The BIA codifies both a cash-flow test and balance sheet test for “insolvent person”.
¹¹ Supra note 1 at s 5(1).
¹² Supra note 2 at § 9-301(1).
¹³ Ibid at § 9-515(a).