Remotely Terminating Equipment Use as Enforcement Remedy Against Default: Understanding the Legal Requirements
Davis LLP Banking & Financial Services Bulletin
April 15, 2013
In recent years, manufacturers and lessors of heavy industrial equipment have installed sophisticated systems into their units which require a computer code be entered in order for the equipment to operate. This computer code may need to be updated or changed periodically. If the purchaser or lessee is in arrears in making payment to the manufacturer or lessor, the manufacturer or lessor may refuse to supply the debtor with the new access code. In effect, the manufacturer or lessor has the ability to remotely render the equipment unusable. Does the Personal Property Security Act of Ontario1 (the “PPSA” or the “Act”) accommodate this enforcement remedy by a secured party? Are there steps that a secured party needs to take before it can determine to not provide the debtor with this new code?
Default of the debtor; notice by the secured party
The PPSA defines “default”2 as the failure to pay or otherwise perform the obligation secured when due or the occurrence of any event of default whereupon under the terms of the security agreement the security becomes enforceable. Upon default, a secured party is entitled to take possession of the collateral by any method permitted by law.3 This right is subject to any agreement by the parties, so that if the security agreement prescribes a time frame after default before a secured party may take action, the courts generally enforce the provisions in the agreement.
However, what about the requirement that the secured party provide the debtor with notice that the debtor is in default under the security agreement and failing rectification, the secured party may seek its remedies under the security agreement and under the PPSA? Even if the security agreement does not contain provisions requiring the secured party to advise the debtor that the debtor has failed to make a payment and accordingly is in default under the security agreement, it is well recognized that both the Bankruptcy and Insolvency Act4 (the “BIA”) and the common law set out requirements before a secured party may proceed.
(a) Bankruptcy and Insolvency Act
Under the BIA, a secured party who intends to enforce a security on “all or substantially all of (a) the inventory, (b) the accounts receivable, or (c) the other property of an insolvent person that was required for, or is used in relation to, a business carried on by the insolvent person”5 must provide that insolvent person with at least ten days’ notice of the secured party’s intention. If it is understood that a debtor who has failed to meet the payment obligation under a security agreement is insolvent, then, a secured party, when refusing to provide the computer code, would have to provide the debtor with notice that the secured party is not intending to provide the new code and is thereby intending to realize upon the equipment, if that equipment would constitute “all or substantially all” of that debtor’s property used in the business.
(b) Common Law
The common law requirements are not as specific. However, ever since the decision in Lister v. Dunlop6 it has generally been held that a minimum notice of one day must be provided to a debtor before a secured party may take action to realize upon its security. The secured party must give the debtor a demand, in writing, for payment and a reasonable amount of time in which to meet the demand. The amount of time usually depends on the circumstances and there are often a number of factors that a court will consider, including the risks to the secured party of losing its security.
(c) Personal Property Security Act
The PPSA itself does not contain any notice requirements when a debtor is in default. Section 59 sets out the rights and remedies of a secured party. It provides that when a debtor is in default under a security agreement, the secured party has the rights and remedies provided in the security agreement and the rights and remedies provided in Part V of the PPSA. Pursuant to subsection (4) of section 59, subject to subsection (5), a security agreement may set out the standards by which the rights of the debtor and the duties of the secured party are to be measured, so long as those standards are not manifestly unreasonable having regard to the nature of the rights and duties. Subsection (5) states that the provisions of sections 17, 17.1 and 63 to 66, to the extent that they give rights to the debtor and impose duties upon the secured party, may not be waived or varied, except as provided by the Act.
As noted above, paragraph 62 (1) (a) merely states that upon default, the secured party, unless otherwise agreed, has the right to take possession of the collateral by any method permitted by law. Paragraph 62 (1) (b) provides that if the collateral is equipment and the security interest has been perfected by registration, the secured party may, in a reasonable manner, render such equipment unusable without removal thereof from the debtor’s premises, and the secured party shall thereupon be deemed to have taken possession of such equipment. There are requirements under the PPSA dealing with how a secured party must act when in possession of collateral and how to dispose of the collateral, but no requirements to give notice to the debtor that the debtor is in default under the security agreement, unless the security agreement so specifies.
So, what does the security agreement need to provide in order for the secured party to withhold providing the debtor with the new necessary computer code? And pursuant to the PPSA, may the secured party only withhold the code updates if the secured party has registered a financing statement pursuant to the Act?
Security agreement provisions
When a computer code must be changed periodically, the security agreement usually contains provisions dealing with this requirement. The security agreement sets out that a new computer code must be entered periodically, usually specifying the time period, to enable the equipment to continue to operate. The agreement may stipulate that the debtor must contact the secured party a number of days in advance of the proposed expiration date for the existing code so as to allow the secured party time to ascertain the debtor’s payment history. If the debtor is current with its payments under the security agreement, then the agreement will state that the secured party will provide the debtor with the new computer code for the next relevant time frame. If the debtor is not current, then the agreement will often provide that the secured party will not and need not provide the new computer code unless and until the debtor brings the payments current. The security agreement may further provide that if the debtor is in default in the payment or performance of its obligations under the security agreement that the debtor acknowledges and agrees that the secured party need not provide the debtor with the new computer code and further that the debtor shall have no right to continue to operate the equipment.
The security agreement may also contain other provisions for the benefit of the secured party. These may include an acknowledgement that the equipment is not all or substantially all of the equipment used by the debtor in the operation of its business, or, alternatively, that the debtor has other equipment available to enable the debtor to continue to carry on its business and to allow the debtor to complete the work that was scheduled to be performed using the equipment. The provisions may also include a statement that the debtor agrees that the failure of the secured party to provide the code is commercially reasonable and necessary to protect the rights of the secured party in the equipment. The security agreement may state that notification by the secured party that it is not providing the new computer code constitutes notice that the debtor is in default under the provisions of the security agreement and that the debtor acknowledges and agrees that no further notice of its default is required. Finally, there may be a provision whereby the debtor agrees that allowing the equipment to remain on the debtor’s premises is commercially reasonable and acknowledges that so doing is not unduly disruptive to the business of the debtor.
So, if the agreement contains some or all of these provisions, what else does the secured party need to do in order to be able to have the equipment effectively shut down when the debtor is not able to enter the new code? If for example, the equipment is a large stamping machine that the debtor relies upon for a majority of its parts production, are the provisions noted above sufficient?
(a) Bankruptcy and Insolvency Act
Notwithstanding that the security agreement may contain a provision whereby the debtor acknowledges and agrees that the equipment is not necessary for the ongoing operations of the business, the inclusion of this provision will not preclude the requirement to comply with section 244 of the BIA. Subsection (2) of section 244 of the BIA sets out that the notice to be provided before the secured party may enforce, shall not be effective until the expiry of ten days after the sending of the notice unless the insolvent person consents to an earlier enforcement. More importantly, subsection (2.1) provides that for the purpose of subsection (2), consent to an earlier enforcement may not be obtained by the secured party prior to the sending of the notice. So, no provision in a security agreement will obviate the need for the section 244 notice if the equipment is all or substantially all of the property used by the insolvent person in operating its business. Although the provision in the agreement to the contrary will give the secured party arguments that the secured party understood that the equipment did not fall within the parameters of section 244 and therefore require the notice and that the secured party thought the debtor had other sufficient means to complete its work, a prudent secured party will send the section 244 notice to the debtor at least ten days before the effective date of the expiry period of the current computer code, if the secured party is aware that the debtor is in default and that a new code is not to be provided, and if the equipment may be deemed an essential part of the business of the debtor.
(b) Common Law
As noted above, the common law requires the debtor to be provided with a demand for payment and a reasonable amount of time to enable the debtor to cure the default by making payment to the secured party. As a result, and notwithstanding what the agreement provides, it would be prudent practice for the secured party to not just rely on advising the debtor that the new computer code is not being provided because the debtor is not current in its payments. The secured party should advise the debtor, in writing, that the debtor is in default, having missed one or more payments, and that if the debtor does not cure the default by the time that the new code needs to be inserted into the equipment, that the secured party will, by not providing the new computer code, take the action it deems necessary to take possession of the equipment. Having the security agreement contain a provision that the debtor acknowledges that being delinquent in making payments constitutes a default may not suffice under the common law to enable the secured party to take action under the PPSA.
(c) Personal Property Security Act
As noted, the PPSA does not contain any provisions that require the secured party to give the debtor notice that the debtor is in default under the security agreement. The PPSA does contain provisions that set out notice and other provisions relevant to enforcement.
Section 62 sets out the provisions for taking possession of equipment. Section 63 describes the steps to be taken in order to dispose of the collateral upon default under a security agreement. And subsection 67(3) of the PPSA provides that unless otherwise specified in the Act, any provision in any security agreement which purports to exclude any duty or obligation imposed under the Act or to exclude or limit liability for failure to discharge duties or obligations imposed by the Act is void.
In order to comply with the provisions of section 62, the collateral must be equipment, the secured party must have perfected its position by registration and the secured party must render the equipment unusable, without removal from the debtor’s premises. Compliance with the foregoing provisions deems the secured party to be in possession of the equipment. Pursuant to this section, the failure to provide the new computer code should render the equipment unusable. Since this would appear to be the intent of the supplier or lessor, the secured party should therefore be deemed to be in possession, without having to further comply with PPSA provisions until the decision to dispose of the equipment.
Consequences of lack of provisions in the security agreement
What happens if the security agreement or lease does not contain some or all of the provisions suggested above regarding the delivery of the new code and the equipment acknowledgments? That is, what if the agreement simply provides that the debtor must request a new computer code on a regular basis and does not contain provisions addressing the failure of the debtor to be current under the terms and conditions of the security agreement? Will the failure of the agreement to contain provisions including the acknowledgements of the debtor regarding the need to be current affect the manner in which the secured party may enforce and the ability of the secured party to refuse to provide the updated code?
(a) Bankruptcy and Insolvency Act
As noted, if the equipment is essential to the debtor to enable the debtor to carry on its business, or constitutes substantially all of the assets of the debtor, then whether or not the agreement provides otherwise, the debtor will need to be provided with the section 244 notice. A prudent secured party would want to ensure that it had time to provide the section 244 notice to the debtor in advance of refusing or delaying in providing the new code. So, the secured party would need to ensure that its security agreement sets out, or its practice in providing this new code information allows it, sufficient time to check the status of the debtor’s payments, that the equipment has been operating properly and that it has provided the debtor with the appropriate notice under the BIA as well as notice advising that if the debtor does not make current the payments under the agreement before the date the new code is to be supplied, that the code will not be forthcoming. Based upon the foregoing, the secured party should start the process to provide the new computer code at least twenty days prior to the anticipated expiry date of the existing code.
(b) Common Law
Regardless of the provisions in the security agreement, the common law requirements in respect of notice remain the same. As a result, if the debtor is in default and the secured party has determined to not provide the new computer code, it is incumbent upon the secured party to advise the debtor in writing of the default and specify that if the default is not cured by the date that the new code is to be inserted into the equipment that the secured party will be exercising its rights in respect of default under the security agreement and will not be providing the new code. The secured party again needs to ensure that its practice is to allow sufficient time to ascertain the status of the debtor’s payment history in advance of providing the new code, in order to provide the debtor with this notice of its default and the statement that if the payment or payments are not made current by that date that the new code will not be forthcoming.
(c) Personal Property Security Act
Since the PPSA does not contain any notice provisions before a secured party may take possession of the equipment by rendering it unusable provided the debtor is in default, all that the secured party needs to do is advise the debtor, in writing, that the debtor is in default. Thereupon, (and anticipating compliance with the common law and the BIA, if necessary), the PPSA seems to allow the secured party to simply not provide the new code to the debtor. However, as noted below, section 62 of the PPSA does contain one condition. The security interest must have been perfected by registration.
Section 62, Personal Property Security Act
Paragraph 62(1) (b) of the PPSA provides that “if the collateral is equipment and the security interest has been perfected by registration, the secured party may, in a reasonable manner, render such equipment unusable without removal thereof from the debtor’s premises, and the secured party shall thereupon be deemed to have taken possession of such equipment”.
Based upon the foregoing, if the manufacturer or lessor has ascertained that the debtor is in arrears of payment or has committed a default under the provisions of the security agreement, such that the manufacturer or lessor is not intending to provide the new computer code, before the secured party can so act, the secured party needs to ensure that it has effected a registration pursuant to the PPSA. The parties cannot agree to waive this requirement as section 67(3) of the PPSA would suggest that waiving this provision under the Act would be void. So, registration is required before a secured party may render equipment unusable, whether by attending on the premises of the debtor or remotely by failing to provide a new access code. (Registration does not seem to be a requirement under the UCC 9.) This registration requirement is notwithstanding the provisions of section 22 of the PPSA that allow for perfection by possession.
Therefore, although there is no notice requirement under the PPSA prior to taking possession of equipment by failing to provide a current computer code, there is a requirement that the secured party have a registration in respect of the equipment.
The introduction of the use of computer access codes to enable machinery to function and the need to replace these codes periodically has provided manufacturers and lessors with an opportunity to effectively monitor payment for equipment and to more easily enforce their security on such equipment, without needing to attend on the premises of the debtor. However, these manufacturers and lessors must still bear in mind the requirements under both the BIA and common law to provide the debtor with notice of default and time to cure the default before failing to provide a current code. In addition, although the PPSA does not contain any notice provisions, in order to obtain “possession” of the equipment, the secured party needs to ensure that it has a valid and enforceable registration in respect of the equipment.
1. Revised Statutes of Ontario 1990, c.P10
2. Ibid. Section 1.1
3. Ibid. Section 62(1)(a)
4. Revised Statutes of Canada 1985, c.B-3
5. Ibid. Section 244
6. Ronald Elwyn Lister Ltd. v. Dunlop Canada Ltd. 135 D.L.R, (3d) 1 (S.C.C.)
M. Sandra Appel