The Effect of an Assignment of Security on Unsecured Claims

Davis LLP Banking & Financial Services Bulletin


Eagle Eye Investments Inc. v. CPC Networks Corp.

"When One Plus One Still Equals One"

Introduction

The numerous motions in the Saskatchewan Court of Queen’s Bench in Eagle Eye Networks Inc. (“Eagle Eye”) and CPC Networks Corp. (“CPCN”) paint a remarkable history of a falling out among the major shareholders of CPCN, who were its first directors and officers, and the many and varied steps taken by two such shareholders to recover monies allegedly loaned by one of them to CPCN. The saga is not yet over. No decision has been made whether CPCN actually owes monies to Eagle Eye. But one decision recently released by the Court has possibly provided certainty and laid to rest an issue that has troubled secured creditors and debtors alike for a long time. Can an unsecured creditor take an assignment of a perfected security position and thereby secure its unsecured debt?

Background

The relevant background information is set out in the judgment of the Court dated November 18, 20111 . CPCN had four initial shareholders, directors and officers. One of these, (“A”), who is also the president, sole director and sole beneficial owner of Eagle Eye, alleges that Eagle Eye loaned monies to CPCN. This loan (the “Eagle Eye Loan”) was not secured. Prior to the Eagle Eye Loan CPCN had entered into a loan agreement (the “Loan Agreement”) with Business Development Bank of Canada (“BDC”). Pursuant to the Loan Agreement BDC had provided CPCN with monies (the “BDC Loan”) and received a general security agreement (“GSA”). BDC was therefore a secured creditor of CPCN.

Eagle Eye commenced an action to recover the Eagle Eye Loan, which action is being strenuously defended. As a result of that action, A was removed as an officer of CPCN. A second initial shareholder, (“B”), who was the president of CPCN and a director, resigned shortly thereafter. After resigning, B incorporated a new company, (“B Company”), and B Company gave notice to CPCN that B Company had taken an assignment of the BDC Loan and GSA. Although B Company demanded payment of the BDC Loan and appointed B as a receiver of CPCN under the GSA, CPCN was successful in obtaining an order setting aside this appointment and enjoining B Company from taking any further action without order of the Court. A and B and others then commenced an oppression remedy against CPCN. The Court determined no oppression by the two remaining original directors, but appointed another director.

Then CPCN received notice that B Company had further assigned the BDC Loan and GSA. The assignee was Eagle Eye. Eagle Eye immediately demanded payment, but in the demand also asked for a significant amount of financial and other information. CPCN determined to pay out the BDC Loan and accordingly asked for a payout statement. Since the payout statement included the monies allegedly loaned by Eagle Eye, a large amount for costs and a very significant interest figure, CPCN commenced an application before the Court for a determination, amongst other matters, of the amount owing by CPCN on the BDC Loan and for an order requiring the discharge of the GSA.

Issue

In determining the amount owing by CPCN to Eagle Eye to obtain a discharge of the GSA, the Court had to determine whether the GSA registered by BDC could also cover the unsecured monies allegedly loaned by Eagle Eye to CPCN. That is, can an unsecured creditor take an assignment of a perfected security position and thereby secure its unsecured debt? Eagle Eye took the position that by virtue of the assignment of the BDC Loan and GSA that Eagle Eye had stepped into the shoes of BDC and accordingly had all the rights and remedies that BDC had under the GSA. One of these rights was that the GSA covered all liabilities owed by CPCN to BDC (now Eagle Eye) whether incurred prior to or after the signing of the GSA. As a result, the GSA could not be discharged until all monies owed by CPCN to Eagle Eye, including the Eagle Eye (previously unsecured) debt had been paid. CPCN countered with the obligation of Eagle Eye to act in good faith; that under the Saskatchewan Personal Property Security Act (“SPPSA”) CPCN is owed a duty of fairness. CPCN further submitted that the SPPSA restricted the ability of an assignee of a secured debt to transform pre-existing, unrelated and unsecured debt into secured debt. Finally, CPCN argued that the GSA was subject to the terms of the Loan Agreement and accordingly when the BDC Loan has been repaid, CPCN is entitled to a discharge of the GSA.

Analysis

The Court first considered section 65 of the SPPSA. Subsection 65(3) of the SPPSA provides that all rights, duties or obligations that arise pursuant to a security agreement, this Act or any other applicable law are to be exercised or discharged in good faith and in a commercially reasonable manner. The Ontario Personal Property Security Act (the “OPPSA”) does not have a similar provision. Section 72 of the OPPSA provides that the principles of law and equity supplement the Act and continue to apply. Section 63 of the OPPSA, which deals with the disposition of collateral by the secured party, imposes obligations of commercial reasonableness. The Court determined that the assignments of the BDC Loan, the Loan Agreement and the GSA from BDC to B Company and from B Company to Eagle Eye were done without the knowledge or consent of CPCN. As well, these assignments were not exercised in good faith nor in a commercially reasonable manner, but rather to enable A and B to obtain an advantage over the other shareholders of CPCN. Finally, the Court stated that these assignments and the GSA were being utilized to enable Eagle Eye to obtain financial information to assist in the oppression remedy, rather than for a commercially reasonable purpose. Notwithstanding these statements, no decision of the Court really turned on them. As a result, it is not necessary to consider whether an Ontario court would have reached a different conclusion on these assignments. The Court did determine later on in its decision that the documents requested by Eagle Eye did not need to be handed over by CPCN; but for a reason unrelated to the bad faith exercised in these assignments.

The significant analysis related to the Loan Agreement and GSA provisions. The Court determined that the GSA was subject to the terms of the Loan Agreement. Therefore, although the GSA did provide, as noted above, that it was “general and continuing security for the payment and performance of all indebtedness, liabilities and obligations of the Borrower to BDC (including interest thereon) whether incurred prior to, at the time of or after the signing of this Security Agreement including extensions and renewals, and all other liabilities of the Borrower to BDC, present and future, absolute or contingent, joint or several, direct or indirect, matured or not, extended or renewed, wherever and however incurred……, and for the performance of all obligations of the Borrower to BDC, whether or not contained in this Security Agreement” (emphasis by the Court), and that the GSA could be assigned without notice to the Borrower, the Court determined that the Loan Agreement takes precedence. Since the Loan Agreement clearly referred to a loan of $150,000 plus interest, it would be contrary to the Loan Agreement to allow Eagle Eye to add its previously unsecured shareholders’ loans to the amount owing under the original Loan Agreement with BDC. The Court further stated that while the GSA does refer to it as being security for all other liabilities of the borrower, that clearly those are liabilities of the borrower to BDC and not loans of third parties.

Reference was made to sections 9 and 65(2) of the SPPSA. Section 9 of the SPPSA is similar to section 9 of the OPPSA and provides that the security agreement is effective according to its terms, unless otherwise provided in the Act or in any other Act. Section 65(2) of the SPPSA refers to the principles of common law, equity and the law merchant. The Court noted that there was nothing in the SPPSA which deals specifically with the circumstances of this case as to the ability of an assignee of a security agreement to enforce not only the debt secured by the GSA but also other debts owed by the debtor to the assignee. The Court did refer to the text on Personal Property Security Law 2 and noted the learned authors’ comment therein that security agreements are often broadly drafted to cover present and future obligations of the debtor to the secured party. Similarly section 35(5) of the SPPSA (section 30(3) of the OPPSA) extends the priority of a secured party to future advances. However, the Court notes that these “authors point out the PPSA does not deal with situations where obligations owed to a third party are assigned to the secured party or where the security agreement is assigned to another”3; in these instances the authors refer to the common law. (The OPPSA does deal with the assignment of a security interest and provides that a financing statement may be registered to enable the assignee to become the secured party of record. There are no provisions however dealing with prior debt being assigned.)

The authors note that courts have been unwilling to permit an assignee to claim the benefit of an all obligations clause in respect of obligations incurred by the assignee before the assignment, and noted that the courts of England, Australia and New Zealand have determined that only if an agreement had the clearest of language would an unsecured creditor be able to obtain secured status by taking an assignment of a security agreement with an all obligations clause. The Court reviewed the cases considered by the authors and also American decisions. The latter were not inclined to allow unsecured creditors and unperfected security interests to become perfected when assigned to a secured party.

The Court considered the “very little case law” concerning this issue. In Canamsucco Road House Food Co. v. Lngas Ltd.4 the Court allowed an assignee to priority over a second secured creditor but only in respect to the assignor’s original secured loan, not in respect of any other indebtedness owed by the debtor to the assignee. In this case, the assignee was also the third secured creditor. If the court had allowed the “merging” the first secured creditor/assignee would have in effect gained priority over the second by buying out the first position. The Court determined that this would have been inequitable.

The second Canadian case cited in this decision was Near Horbay Inc. v. Great West Golf & Industrial Inc.5 In this situation, the assignee took security from the first secured creditor, but also assignments of debt from other unsecured creditors in an attempt to gain priority over the second secured creditor. The Court refused to permit the assignee to gain priority with respect to the unsecured debts. This would seem to be analogous to the claim being made by Eagle Eye. The Court in Horbay stated that “the predictability and reliability of the system, and the integrity of the priority structure designed by the Personal Property Security Act, would not be served by this, and yet the risk of stultifying credit would be real.”6

The Court then referred to an article written by Roderick J. Wood entitled “Turning Lead into Gold: The Uncertain Alchemy of ‘All Obligations’ Clauses”.7 The Court referred to the three reasons that the author cited why courts have been unwilling to convert unsecured claims into secured claims in the assignment of security situations: (i) it would be unfair to the debtor; (ii) it would have a destructive impact on the principle of pro rata sharing in bankruptcy law; and (iii) it would have a disruptive effect on the PPSA regime with a subsequent loss of predictability. Although all three reasons are valid and the Court advises could be applied to this case, the disruption of PPSA priorities is significant. If the argument of Eagle Eye were to succeed, not only could any unsecured creditor become secured, but any unsecured creditor with a large amount due and owing, could upset the priorities established under the PPSA in respect of first in time by acquiring an insignificant prior secured position and tacking on a large unsecured debt. The Court determined that the GSA did not cover previously unsecured debts owed by CPCN to Eagle Eye. The only amount to be paid to discharge the GSA was the amount owing to BDC.

Summary

In summary, an unsecured creditor taking an assignment of a perfected security position cannot thereby secure its own previously unsecured debt; it can only get the debt due and owing to the assignor that was previously secured.
 


1CPC Networks Corp v Eagle Eye Investments Inc., 2011 SKQB 436 (CanLII)

2by Ronald C.C. Cuming, Catherine Walsh and Roderick J. Wood (Toronto: Irwin Law Inc., 2005)

3Supra at para. 28.

4(1991), 2 PPSAC (2d) 203 (Ont. Ct. Gen. Div.) rev’d on other grounds (1997), 12 PPSAC (2d) 227 (Ont. C.A.)

52000 ABQB 861 (CanLII)

6Ibid., para. 90

7(2004), 41 Alta. L. Rev. Rev.801 at 809

 

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