Following and Tracing into New Forms of Collateral

AuthorRonald C.C. Cuming, Catherine Walsh, Roderick Wood
Pages552-612
552
CHAPTER 11
FOLLOWING AND
TRACING INTO NEW
FORMS OF COLLATERAL
A. OVERVIEW
1) Following and Tracing
A secured party may assert a personal or proprietary claim based upon
the secured party’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 indeed subject to the security interest. There are
two distinct processes that may precede the assertion of a claim by a
secured party. The f‌irst involves following the collateral. The second
involves tracing into the proceeds of the collateral.
The objective of following is to locate and identify the collateral.
If the secured party wishes to enforce its security interest against the
asset, it must show that it was the same asset 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 isv 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 necessary 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 Collateral553
A secured party (SP) holds a security interest in the debtor’s (D’s)
boat. D sells the boat and takes a motorcycle as part of the price. D
then sells the motorcycle to a buyer (B).
SP may claim a security interest in the motorcycle as proceeds aris-
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 that has been transferred to a third party,
it is necessary for the secured party to demonstrate that this property
was subject to its security interest. This is an exercise in following col-
lateral. If the transaction results in the receipt of assets 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 is a kind of property interest, and therefore physical
destruction of the collateral will result in a loss of the security 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 as a separate thing can still be said to exist.
This may occur where goods are processed 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).
PERSO NAL PROPERT Y SECUR ITY LAW554
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 with other goods of the same description. In this
case, the owner obtained 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 available under the common law. The se-
curity interest is not as easily lost upon a transformation of the goods.4
If the goods become an accession or a f‌ixture, the secured party will
typically h ave the right to remove it. In the ca se of a loss of identity due
to the goods being manufactured or processed, the security interest
is not lost but instead continues in the f‌inished product. Because the
secured party has a greater ability to assert its security interest in the
f‌ixture, accession, or new product, it becomes necessary to provide an
expanded set of priority rules in the PPSA to determine the outcome of
the priority disputes that will inevitably arise.
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 eliminates 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 FlintoftvRoyal 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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