Following and Tracing into New Forms of Collateral

• Author: Ronald C.C. Cuming, Catherine Walsh, Roderick Wood
• Pages: 552-612

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