Following and Tracing into New Forms of Collateral
| Author | Ronald C.C. Cuming/Catherine Walsh/Roderick J. Wood |
| Profession | University of Saskatchewan, College of Law/McGill University, Faculty of Law/University of Alberta, Faculty of Law |
| Pages | 452-510 |
CHAP TER 12
FOLLOWING AND
TRACINGINTONEW
FORMSOFCOLLATERAL
A. OVERVIEW
1) Following and Tracing
A secured party may assert a per sonal or proprietary cl aim based upon
the secured part y’s security intere st in the collateral.1 Before being in
a position to do so, the secured part y must demonstrate that the prop-
erty in question was indeed subject to the security interest. There are
two distinct processes that may precede t he assertion of a claim by a
secured part y. The first involves following the collateral. The second
involves tracing into the procee ds of the collateral.
The objective of following is to locate and identify the coll ateral.
If the secured party wishes to enforce its sec urity interest agai nst the
asset, it must show that it was the same asset that was g iven to the se-
cured party a s collateral. Tracing does not seek to identify t he original
collateral. Instead it looks to new propert y that was obtained as a result
of a dealing with t he original coll ateral. This new property is viewed as
a substitute for the original coll ateral, and the secured pa rty is thereby
permitted to clai m a security interest in it.
It may be necessar y to conduct an exercise in both tracing and fol-
lowing. This is illust rated in the following scena rio.
1 See chapter 13, A.1 “Persona l Claims and Propriet ary Claims.”
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Following and Tracing i nto New Forms of Collateral 453
A secured part y (SP) holds a security interest in the debtor’s (D’s) boat. D
sells the boat and takes a motorc ycle as part of the price. D then sells t he
motorcycle to a buyer (B).
SP may claim a secur ity interest in the motorcycle as proceeds aris -
ing out of the dealing with t he 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 t he same one that earlier had b een
received by D. This step involves following. If the traci ng and following
exercises are succes sful, SP may asser t that it has a secur ity interest
in the motorcycle in the hand s of B. This does not mean that SP w ill
necessari ly succeed against B. This w ill be determined by t he priority
rules of the PPSA. But if SP cannot show a basis for claiming a secur ity
interest in the motorcycle in the poss ession of B, it will not even get out
of the starting gate.
The PPSA expressly recognizes the disti nction between following
collateral and traci ng proceeds. It provides that where collateral is dea lt
with so as to give r ise to proceeds, the security interest cont inues in the
collateral and also ex tends to the proceeds.2 In order to assert a secur-
ity interest in the propert y that has been t ransferred to a third party,
it is necessar y for the secured party to demonst rate that this property
was subject to its securit y interest. This is an exercise in following col-
lateral. If the tran saction results in t he receipt of assets by way of ex-
change, the securit y interest will conti nue in the proceeds. This is an
exercise in trac ing 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 de stroyed, the property r ight comes to an end. A
security interest is a kind of property intere st, and therefore physical
destruction of the collateral will result in a los s of the security i nter-
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 identit y as a separate thing can still b e 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 s o as to
lose their separate identity.
2 PPSA (A, BC, M, NB, NWT, Nu, PEI, S) s. 28(1); (NL, NS) s. 29(1); O s. 25(1);
Y s. 26(1).
PERSO NAL PR OPERTY SEC URI TY LAW454
Und er th e comm on la w, an in tere st in prope rty can b e los t by s peci -
fication (that is, the transformation of the goods into a new thing), by
accession (that is, becoming attached to other goods) or by becoming a
fixture (that is, becoming attached to land). However, a property inter-
est is not lost upon the goods being mi xed with other goods of the same
description. In thi s case, the owner obtained an interest in t he mixture
that is proportionate to the owner’s contribution to the mix ture.3
A security intere st under the PPSA provides the secured party w ith
a more robust right than is avai lable under the common law. The se-
curity interest is not as easily lost upon a transform ation of the goods.4
If the goods become an accession or a fixture, the secured pa rty will
typically h ave the right to remove it. In the case of a loss of identity due
to the goods being manufactured or processed, the sec urity interest is
not lost but instead continues in the fin ished product. However, in each
of these case s an exercise in following i s necessar y in order to demon-
strate that it was the or iginal collateral, and not some other property
of the debtor, that was transformed. Bec ause the secured par ty has a
greater ability to as sert its secur ity interest in the fixture, accession, or
new product, it becomes necessar y to provide an expanded set of prior-
ity rules in the PPSA to determ ine the outcome of the priority disputes
that will inevitably arise.
3) Tracing Value into New Assets
Tracing permits “one asset to stand i n place of another for certain legal
purposes.”5 In the context of a secured transaction, a secured pa rty
may seek to claim that assets that were obtained by a debtor upon the
disposition of the secured party’s collateral are s ubject to its secur-
ity interest. Before the PPSA, there was considerable uncertainty con-
cerning the ability of a secured party to claim a secur ity interest in
3 There is uncert ainty on whether this i nterest involves co-owne rship of the bulk
or if it involves recog nition of a continuing owner ship in the contribution. S ee P.
Birks, “Mixt ures” in N. Palmer and E. McKendr ick, eds., Interests in Goods, 2d ed.
(London: LLP Referenc e Publishing, 1998) at 461 (advocating co-ow nership); L.
Smith, The Law of Tracing (Oxford: Clarendon P ress, 1997) at 75–77 (advocating
continuing ow nership). The rules di ffer if one of the contributors i s a wrongdoer.
4 The PPSA provision s might equally be conceptu alized as involvin g the creation of
a new property r ight in the transforme d asset rather than a s a continuation of the
origina l right. However, as the PPSA provides a set of r ules 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 rig ht or a continuation of the origin al right.
5 Smith, above note 3 at 17.
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