B. Secured Creditors

Author:Roderick J. Wood
Profession:Faculty of Law. University of Alberta
Pages:119-131
 
INDEX
FREE EXCERPT

Page 119

Creditors who have taken the precaution of obtaining a security interest are able to assert a proprietary claim to some or all of the bankrupt’s

Page 120

property. The pervasive use of secured credit in modern times has meant that these claims arise routinely. Indeed, it has occurred to such a degree that some commentators have expressed concern that it has permitted most of the bankrupt’s assets to be swept out of the bankrupt’s estate, leaving nothing at all for the unsecured creditors.9

A secured creditor’s enforcement remedies against the collateral are not regulated by the bankruptcy system and continue to be governed by non-bankruptcy law principles. Personal property security law generally governs enforcement proceedings against personal property while provincial mortgage foreclosure law generally governs proceedings against land.10The exercise of these enforcement remedies results in the removal of the collateral from the bankruptcy estate. The proceeds from the realization of the collateral are not shared among the creditors but are used to satisfy the obligation owed to the secured creditor. If there is a surplus following an enforcement sale, the trustee is entitled to claim the proceeds unless there is another party with a higher right (such as the holder of a subordinate perfected security interest). A secured creditor will typically assert a claim in bankruptcy only if the value of the collateral is not sufficient to satisfy the obligation secured.

1) The Definition of Secured Creditor

The BIA defines a "secured creditor" as "a person holding a mortgage, hypothec, pledge, charge or lien on or against the property of the debtor" that secures a debt.11This definition covers security interests in both real property and personal property. It encompasses security rights that arise by operation of law or by statute (non-consensual security interests) as well as consensually created security interests. The definition therefore covers a common law possessory lien of a repairer as well as a non-possessory statutory lien given to a garage keeper. Legislation may give the provincial or federal Crown a non-consensual security interest in the debtor’s property to secure an obligation owing to the Crown. Although the Crown falls within the definition of a secured creditor, it

Page 121

will not be able to assert its secured creditor status unless an additional registration requirement is satisfied.12If the claim is one that is given the status of a preferred claim in bankruptcy, the holder of the claim is unable to rely upon any provincial law that would confer a secured creditor status upon the claimant.13

This is illustrated in the treatment afforded landlords who have exercised a right of distress against goods located on the leased premises. Prior to 1949, a distraint claim of a landlord fell within the definition of a secured creditor. In 1949 the bankruptcy legislation was amended so as to provide that the claim for distress was a preferred claim in bankruptcy. Thereafter, landlords who exercised a right to distress were no longer regarded as secured creditors.14Provincial personal property security law deems certain types of transactions to be security interests for the purpose of the legislation. Leases and consignments that do not in substance create a security interest and absolute transfers of accounts are brought within the scope of the legislation. The definition of secured creditor in the BIA does not cover lessors, consignors, or assignors who are deemed to be secured parties under provincial legislation.15Claims by such parties should be dealt with under the general procedure for resolving proprietary claims, rather than the procedure set out for secured creditors. A failure to register or perfect these interests may nonetheless result in their subordination to the trustee under personal property security legislation.

Unfortunately, it is less clear whether conditional sales agreements, leases, and consignment arrangements that would be regarded as true security interests under personal property security legislation are caught by the definition. These transactions did not create security interests under the common law but were brought within personal property security legislation by virtue of a wider test that looked to the substance and economic realities of the transaction. The definition of secured creditor in the BIA does not employ a similar test. Although it brings conditional sales and title-retention devices within the scope of the definition in respect of the Civil Code of Quebec, it fails to do so in respect of common law jurisdictions.

In other contexts, the failure to provide language that covers these transactions has meant that federal legislation did not extend to con-

Page 122

ditional sales agreements and security leases.16There is no reason in principle why the BIA provisions that relate to secured creditors should not apply to conditional sales agreements, security leases, and security consignments. The real difficulty will be in explaining why the same interpretive approach is not applied to similarly worded legislation.17

Although the definitional question was not directly addressed, the Supreme Court of Canada in Re Giffen18seems to have proceeded on the basis that a security lease fell within the definition of a secured creditor. This may be enough to dissuade parties from attempting to argue that these types of transactions are not caught by the definition.

2) Asserting Secured Creditor Status against the Trustee

The BIA sets out a special procedure that applies when a secured creditor wishes to assert a security interest in property that has vested in the trustee. This special procedure supersedes the general procedure for asserting proprietary claims against the trustee.19If the trustee believes that property may be subject to a security interest, the trustee may demand that a person file a proof of security that gives full particulars of it.20If the person does not do so within thirty days of service, the trustee, with leave of the court, can sell or dispose of the property free of the security interest.21Although a trustee can sell the collateral with-

Page 123

out following this procedure, the buyer will not take the interest free of the security interest.22

The trustee is required to examine the proof of security and may require further evidence to support the claim.23The trustee has the right to inspect the collateral if it is in the possession of the secured party.24

The trustee may disallow the claim in whole or in part and, upon doing so, must give a notice to the secured creditor setting out reasons.25

The determination by the trustee is final and determinative unless the secured party appeals the decision to court within thirty days after service of the notice or such other period as the court may order.26The bankrupt and the other creditors also have standing to challenge the validity of a security interest if the trustee declines to do so.27

If the trustee is dissatisfied with the assessed value of the collateral in the proof of security, the trustee may require that the collateral be offered for sale.28Alternatively, the trustee can redeem the security interest by paying to the secured creditor the assessed value of the collateral, or the obligation secured if it is less than the assessed value.29A secured creditor can force the trustee to make an election between the right to force a sale and the right to redeem.30If the trustee does not respond within one month or such further time ordered by the court, the right to take either action is lost.

3) Non-Compliance with Validity and Perfection Requirements

Statutes that govern secured transactions frequently impose registration or other perfection requirements. Non-compliance with these provisions often will result in subordination of the security interest to the interests of a trustee. Except in one instance, this does not arise by virtue of bankruptcy law. Instead, it arises because the law that gov-

Page 124

erns the secured transaction mandates this result. If the statute does not provide for subordination to the trustee, the proprietary right will be fully recognized in the bankruptcy despite non-compliance with the registration requirement.

The BIA imposes a registration requirement on assignments of present or future book debts by a person engaged in trade or business.31

Failure to register renders the assignment void against the trustee. The provision was added to the bankruptcy statute in 1921. At the time, provinces did not impose a registration requirement on assignments of book debts. Following this amendment, provinces introduced legislation that created registry systems for the assignment of book debts, and this feature has been retained in provincial legislation relating to personal property security. The BIA does not provide a mandatory registration requirement for any other kind of security interest. The effect of non-compliance with registry requirements therefore falls to be determined by the secured transaction law that governs the security interest. In most cases, it is provincial law that governs this question.

A security interest that is governed by provincial legislation on personal property security must satisfy two conditions in order for it to be effective against a trustee. First, a security interest must satisfy certain formal requirements in order to be effective against third parties. A non-possessory security interest is not enforceable against a third party unless it is in writing and provides an adequate...

To continue reading

FREE SIGN UP