Following and Tracing into New Forms of Collateral

AuthorRonald C.C. Cuming, Catherine Walsh, Roderick Wood
1) Following and Tracing
A secured party m ay assert a personal or proprietary claim based upon
the secured part y’s security interest in the collateral.1 Before being in
a position to do so, the secured party must demonstrate that the prop-
erty in question was i ndeed subject to the security interest. There are
two distinct process es that may precede the asser tion of a claim by a
secured party. The f‌irst involves following the collateral. The second
involves tracing into the proceeds of the coll ateral.
The objective of following is to locate and identify the collateral.
If the secured part y wishes to enforce its securit y interest against the
asset, it must show that it was the same a sset that was given to the se-
cured party as collateral. Tracing does not seek to identify the original
collateral. Instead it looks to new property t hat was obtained as a result
of a dealing with t he origin al collateral. Thi s new property is v iewed as
a substitute for the original collateral, and the secured party is thereby
permitted to claim a security interest in it.
It may be necessar y to conduct an exercise in both tracing and fol-
lowing. This is illustrated in the following scenario.
1 See Chapter 12, Se ction A(1).
Following and Tracin g into New Forms of Collateral 553
A secured party (SP) holds a security interest in the debtor’s (D’s)
boat. D sells the boat and take s a motorcycle as part of the price. D
then sells the motorcycle to a buyer (B).
SP may claim a secur ity interest in the motorcycle as proceeds ari s-
ing out of the dealing with the original collateral. This step involves
tracing. Having done so, SP may then attempt to demonstrate that the
motorcycle in the hands of the B is the same one that earlier had been
received by D. This step involves following. If the tracing and following
exercises are successful, SP may assert that it has a security interest
in the motorcycle in the hands of B. This does not mean that SP will
necessarily succeed against B. This will be determined by the priority
rules of the PPSA. But if SP cannot show a basis for claiming a security
interest in the motorcycle in the posse ssion of B, it will not even get out
of the starting gate.
The PPSA expressly recognizes the distinction between following
collateral and tracing proceed s. It provides th at where collateral i s dealt
with so as to give ri se to proceeds, the security interest continues in t he
collateral and also extends to the proceeds.2 In order to assert a secur-
ity interest in the property t hat has been tran sferred to a third party,
it is necessary for the secured party to demonstrate th at this property
was subject to its security i nterest. This is an exercise in following col-
lateral. If the transaction results in the receipt of asset s by way of ex-
change, the security interest will continue in the proceeds. This is an
exercise in tracing proceeds.
2) Following Collateral into New Products
A property right is a right in relation to a thing. If the subject matter of
the property right is destroyed, the property right comes to an end. A
security interest i s a kind of property interest, and therefore physical
destruction of the collateral w ill result in a loss of the secur ity inter-
est. However, matters are not always so clear-cut. The collateral may
have been transformed i n some fundamental way, and the question will
arise whether its identity a s a separate thing can sti ll be said to exist.
This may occur where goods are proces sed or manufactured into a new
product, or where goods are attached to other goods or to land so as to
lose their separate identity.
Under the common law, an interest in property can be lost by
specif‌ication (the transformation of the goods into a new thing), by
2 PPSA (A, BC, M, NB, NW T, Nu, PEI, S) s 28(1); (NL, NS) s 29(1); O s 25(1); Y s
26( 1).
accession (becoming attached to other good s) or by becoming a f‌ixture
(becoming attached to land). A property interest is not lost upon the
goods being mixed w ith other goods of the same description. In t his
case, the owner obtai ned an interest in the mixture that is proportion-
ate to the owner’s contribution to the mixture.3
A security interest under t he PPSA provides the secured party with
a more robust right than is avail able under the common law. The se-
curity interest is not as e asily lost upon a transformation of the goods.4
If the goods become an accession or a f‌ixture, the secured party w ill
typically h ave the right to remove it. In the ca se of a loss of identity due
to the goods being manufact ured or processed, the security i nterest
is not lost but instead continues in the f‌ini shed product. Because the
secured party h as a greater ability to assert its security interest in the
f‌ixture, accession, or new product, it becomes necessa ry to provide an
expanded set of priority r ules in the PPSA to determine the outcome of
the priority disputes that will inevitably ar ise.
3) Tracing Value into New Assets
Tracing permits “one asset to stand in place of another for certain legal
purposes.”5 In the context of a secured transaction, a secured party
may seek to claim that assets that were obtained by a debtor upon the
disposition of the secured party’s collateral are subject to its secur-
ity interest. Before the PPSA, there was considerable uncertainty con-
cerning the ability of a secured party to claim a security interest in
proceeds.6 The PPSA elimin ates any doubt on this matter by expressly
3 There is uncert ainty on whether this i nterest involves co-owner ship of the bulk or
if it involves recogn ition of a continuing ownersh ip in the contribution. See P Birk s,
“Mixture s” in N Palmer & E McKendrick, eds , Interests in Goods, 2d ed (London:
LLP Reference Publ ishing, 1998) at 461 (advocating co-ownersh ip); L Smith, The
Law of Tracing (Oxford: Clarendon Press, 1997) at 75–77 (advocat ing continuing
ownership). The rules dif fer if one of the contributors is a w rongdoer.
4 The PPSA provision s might equally be conceptua lized as involving t he creation of
a new property r ight in the transformed a sset rather than as a c ontinuation of the
origina l right. However, as the PPSA provides a s et of rules that govern prior ity
competitions over t he transformed ass et, it is unnecessar y to determine if the
property ri ght is conceptually a new right or a cont inuation of the origina l right.
5 Smith, above note 3 at 17.
6 A secured party ’s clai m to proceeds was recogni zed in respect of a Bank Act
security b y the Supreme Court of Canada in Fl intoft v Royal Bank of Canada,
[1964] SCR 631. Although ther e was uncertainty over whet her the claim de-
pended upon the ex istence of an express tr usts proceeds claus e in the security
agreement, or if it a rose because the Bank Act is s aid to effectively vest “owner-
ship” of the goods in t he bank, the Saskatchewa n Court of Appeal in Royal Bank

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