April 20, 2016

Revised Perfection Rules Come to Canada

Martin Fingerhut

On December 31, 2015, there was an important change to the perfection rules under Ontario’s Personal Property Security Act (PPSA).

One might pause to ask why this should be of any interest to U.S. attorneys and their security-taking clients. The simple reason is that U.S. financings increasingly involve Canadian collateral and must therefore take into account Canadian perfection requirements. For one thing, cross-border secured loans to Canadian borrowers have grown significantly following Canada’s virtual elimination, in 2008, of withholding tax on interest paid under non-arm’s length transactions, making these loans easier and less costly. As well, U.S. lenders continue to rely on secured guarantees from Canadian affiliates of U.S. borrowers, and U.S. securitization and factoring transactions commonly involve Canadian trade and consumer receivables. All of these transactions should be perfected in accordance with the rules in effect in the jurisdiction where the debtor and/or collateral is located.

Some history: Modern Canadian secured transactions law dates from 1967, when Ontario enacted the first Canadian PPSA, which was based on the 1962 version of Article 9 of the Uniform Commercial Code (UCC). Following amendments and the development of a computerized central system, the Ontario legislation came into force in 1976, and was succeeded over the next several years by similar, although not identical, legislation in the eight Canadian common law provinces and three territories. Quebec took a unique approach based on the civil law concepts that underlie its legal system.

From the beginning, the UCC and the PPSA have played legal hopscotch, resulting in more and more harmonization between U.S. and Canadian secured transactions laws. Article 9 of course developed the basic concepts, and much of the language, found in the Canadian PPSAs. Ontario’s pioneering lead with electronic filing was then picked up in Article 9 revisions. More recently, UCC Article 8’s approach to perfecting security over investment property was introduced across Canada. However, one striking difference between the two North American regimes endured: the conflicts rules determining where to file a financing statement when the collateral or debtor is located in a particular state, province, territory or other jurisdiction. On December 31, 2015, harmonization of Article 9 and the Canadian PPSAs took another step forward.

It may initially be useful to point out what didn’t change. While Article 9 generally requires security over various tangible items of collateral to be perfected in accordance with the law of the jurisdiction where the debtor is “registered,” all Canadian PPSAs take the pre-Revised Article 9 approach of looking to the law of the jurisdiction where the collateral is located (except for certain “mobile goods”). This difference in the U.S. and Canadian perfection systems will remain.

What has changed, although currently only in Ontario, are the PPSA perfection rules for collateral (referred to in this article as Specified Collateral) that consists of (i) intangibles (e.g., accounts receivable, cash collateral accounts, contract rights, and intellectual property), (ii) inventory or equipment that is leased or held for lease by a debtor to others and is of a type normally used in more than one jurisdiction (e.g., motor vehicles and rolling stock), (iii) non-possessory security interests in instruments (e.g., certain cheques and letters of credit), negotiable documents of title, money, and chattel paper (e.g., conditional sale contracts and certain leases), and (iv) investment property (if the security interest in the investment property is perfected by registration). While the debtor’s “location” will continue to be determinative, that location will, as under Article 9, now depend on the nature of the debtor rather than where the debtor carries on business or resides.

Ontario’s debtor location rule had previously required the secured party to perfect a security interest in Specified Collateral (including purchases of accounts receivable and chattel paper) in accordance with the internal laws of the jurisdiction where the debtor had its place of business, chief executive office or principal place of residence when the security interest attached. Searches for prior registrations affecting such property were commonly conducted in the same place.

This debtor location rule increasingly came to be recognized as being deficient. In many scenarios the parties could not pinpoint the debtor’s chief executive office with absolute certainty – such as when the debtor’s directors, places of business and senior management were located in different provinces, or when the debtor was a Canadian subsidiary of a U.S. parent that oversaw, and perhaps directed, the debtor’s decisions. Choosing the most likely location of a debtor’s chief executive office provided neither adequate comfort nor a clean perfection opinion. As a result, given the importance of proper perfection, secured parties invariably opted for leaving nothing to chance and registered financing statements in every jurisdiction where the debtor might reasonably be viewed as having its chief executive office – leading to delay and increased costs.

Following years of discussion and deliberation, Ontario accepted the recommendation of an advisory committee to adopt the Article 9 approach for perfecting security interests in Specified Collateral. In 2006, legislation amended the Ontario PPSA to replace the debtor location test with one that considered the nature of the debtor entity rather than its physical location. To mitigate conflicts with other PPSA jurisdictions, Ontario decided to delay bringing the amendment into force until at least a substantial number of the other PPSA jurisdictions implemented a similar perfection approach. Years passed without any other jurisdiction following Ontario’s lead, although both British Columbia and Saskatchewan have passed, but not proclaimed into force, similar changes. So, as it did in 1976 when it enacted the first PPSA, Ontario took the lead and brought its amended legislation into effect on December 31, 2015. It would not be surprising to see each of the other PPSA jurisdictions mirror Ontario’s amendment in the coming years.

Ontario’s new debtor location rule is for the most part relatively straightforward and certain, and will apply whether or not Ontario law is expressed to govern the applicable security agreement. As under Article 9, the nature of the debtor, rather than where the debtor carries on business or resides, determines where a financing statement must be registered. So, for example, if a debtor corporation was incorporated in Nova Scotia but carries on business only in Ontario, the revised Ontario perfection rule for Specified Property will require registration in Nova Scotia, while the previous Ontario rule would have required registration in Ontario, as would the current Nova Scotia rule. Different rules under the Ontario amendment apply to different types of debtors, including individuals, corporations, general and limited partnerships and trusts.

Here's the complete list:

Debtor Type

Debtor’s Location

Individuals

The individual’s principal residence

Partnerships (other than limited partnerships) whose partnership agreement states that the agreement is governed by the laws of a Canadian province or territory

The jurisdiction whose law is stated to govern the partnership agreement

Corporations, limited partnerships and other organizations that are incorporated, continued, amalgamated or otherwise organized under the law of a Canadian province or territory that requires disclosure of the debtor’s organization in a public record

The province or territory under whose law the debtor was organized

Corporations that are incorporated, continued or amalgamated under Canadian federal law if such law requires disclosure of the debtor’s organization in a public record

The jurisdiction where the corporation’s registered or head office is located (i) as set out in the statute, letters patent, articles, or other constating instrument under which the debtor was organized, or (ii) if clause (i) does not apply, as set out in its bylaws

Debtors organized under a law of a U.S. state, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, or any territory or insular possession subject to U.S. jurisdiction (a “U.S. State”) if such law requires disclosure of such organization in a public record

The U.S. State under whose law the debtor was organized

Debtors organized under U.S. federal law if such law requires disclosure of such organization in a public record

(i) The U.S State designated by U.S. federal law as the debtor’s location, (ii) the U.S. State designated by the debtor as its location if U.S. federal law authorizes such designation, or (iii) if clauses (i) and (ii) do not apply, the District of Columbia

One or more trustees acting for a trust

(i) The Canadian province or territory whose laws govern the applicable trust instrument as stated in such instrument, or (ii) if clause (i) does not apply, the jurisdiction where the administration of the trust by the trustees is principally carried out

If none of the above apply

The jurisdiction where the debtor’s chief executive office is located

Until harmonization of perfection rules across Canada, the facts of a transaction, and the conflicts rules of the various provinces, may require the secured party to file financing statements, and search for prior registrations, in multiple jurisdictions.

The new Ontario legislation also implements a somewhat complex set of “transitional” rules to deal with a number of issues including, in particular, maintaining perfection and priority of pre–December 31, 2015, security interests, and dealing with amendments to pre–December 31, 2015, security agreements. Continued perfection of such prior security interests will, if Ontario law is relevant, require compliance with these transitional rules. For example, the Ontario amendment provides that a security interest perfected by registration before December 31, 2015, will continue perfected only until the earlier of (i) the day perfection ceases under the pre–December 31, 2015, rules and (ii) December 31, 2020 (even where the registered term of the applicable financing statement would otherwise expire after that date). Secured parties should therefore review their current registrations and determine whether, and when, to re-perfect under the new Ontario rules. As well, the new rules will apply to perfecting a security interest in collateral that, on or after December 31, 2015, is added to a pre–December 31, 2015, security agreement as a result of an amendment to that agreement. Other transitional rules govern the validity of pre–December 31, 2015, security agreements.

Almost 50 years have passed since Canada enacted its first modern secured transactions law. With Ontario aligning a portion of its perfection rules with that of Article 9, we have come one step closer to a harmonized North American personal property security regime.

Martin Fingerhut

After over 40 years of practising with prominent Canadian law firms, Martin Fingerhut established Fingerhut Law Canada to assist Canadian, U.S., European, and other international businesses and their legal counsel in connection with Canadian and cross-border issues.