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Modernizing Canada's Secured Transactions Law: The Bank Act Security Provisions

6. Options for Reform

The Commission has identified three possible options for reform. The first would retain the Bank Act security system, but introduce amendments that would eliminate some of the problems that have been identified. The second would replace the present Bank Act system with a modernized federal personal property security system. The third approach would repeal the Bank Act security provisions. Each option will be described with a discussion of its advantages and disadvantages.

a. Amend the Bank Act Provisions

The first option would retain the Bank Act security provisions, but introduce amendments that would eliminate the priority problems that have been identified. Banks would continue to be able to take Bank Act security to secure their loans. However, the amendments would introduce priority rules that would provide greater legal certainty and, therefore, more predictable outcomes. When a priority competition arose between a Bank Act security and a provincial or territorial security interest, the outcomes would be more commercially sensible.

Some of the legal uncertainty that plagues this area of the law stems from the archaic terminology employed by the Bank Act provisions. Some of this uncertainty could be reduced by eliminating or reformulating some of the statutory provisions. For example, the “document of title fiction” could be abolished. In its place the statute could make it clear that the proprietary interest that is obtained by the bank is in the nature of a security right. The debtor would remain the owner of the collateral, but the bank would obtain an interest that would be characterized as a fixed legal charge in the common law jurisdictions or as an accessory real right under Quebec's civil code. Other provisions that contribute to legal uncertainty, such as the provision that gives the bank a “first and preferential lien” could also be eliminated.

Under this option, it would be necessary to introduce into the Bank Act a reformulated set of priority rules which would govern competitions between a Bank Actsecurity and a provincial or territorial security interest. This could be accomplished by maintaining the separate federal and provincial/territorial registry systems. A Bank Act security would continue to be registered in a federal registry, while provincial or territorial security interests would be registered in the provincial or territorial registry systems. [1] The federal provisions would then be modified so as to provide a first-to-register rule of priority. Although the registration location would differ depending on whether a Bank Act or provincial/territorial security interest was involved, priority would be awarded to the first secured party to register its interest. This would solve some of the difficulties experienced under the present law. For example, a Bank Act security would no longer be defeated by an unregistered provincial or territorial security interest.

In drafting a federal first-to-register rule of priority, a number of complex design issues would need to be addressed. Many of these issues arise because the federal rule would need to properly interact both with the PPSA in the common law jurisdictions as well as the Civil Code of Quebec. There would also be difficulties in determining which transactions would be governed by the federal first-to-register rule of priority. The PPSA jurisdictions look to the substance of the transaction to determine if the transaction is a security interest. A similar approach is not adopted in Quebec. Even among the common law jurisdictions, there are differences about which transactions are subject to a registration requirement. For example, true leases and consignments are not required to be registered in Ontario, but registration of such transactions is required in certain cases in the other jurisdictions. Although it is conceivable that these problems might be satisfactorily resolved by an extremely detailed set of priority rules that took into account the different regimes in the provinces and territories, it is likely that the statutory provisions would be extraordinarily complex and difficult to apply.

A further disadvantage of this option is that it would still be necessary for third parties to conduct dual registry searches. A search of both the federal registry and the provincial or territorial registry would be required to determine if the debtor's property is subject to a security interest. Consequently, this option would not reduce the transaction costs of registering and searching in additional registry systems.

b. Create a Federal Personal Property Security Act

The second option would be to replace the present Bank Act system with a modernized federal personal property security system that incorporates many of the features found in the provincial/territorial systems. This option would mean repealing sections 427 to 429 of the Bank Act and enacting a federal Personal Property Security Act based on the same language, concepts and structure as provincial or territorial legislation. The priority rules of this new federal statute would be harmonized with provincial and territorial law to provide similar priority rules (i.e., a first-to-register rule of priority, subject to a number of exceptions such as the purchase-money security interest super-priority).

This option would solve some of the priority problems that have been identified. In the common law jurisdictions, it would also reduce some of the existing complexities. Presently, users must understand two fundamentally different personal property security systems. If both the federal and the provincial/territorial systems in the common law jurisdictions shared the same terminology, concepts and approaches, this complexity would be reduced.

A major weakness of this option is its complete disregard of the principle of bijuralism. Although the civil code system of Quebec incorporates many features found in the personal property security regimes in the common law jurisdictions, it remains a conceptually distinct secured transactions regime. While there are commonalities between these two systems, there are also many profound differences. Imposing a federal personal property security regime in Quebec, which is based on a model used in the common law jurisdictions, would not solve the problems of incoherence that will inevitably arise when the federal and provincial/territorial systems use fundamentally different concepts and principles.

As with the first option, the disadvantage of this alternative is that it still will be necessary for third parties to conduct searches of both the provincial or territorial and federal registries to determine if the debtor's property is subject to a security interest. Indeed, under this option this would become a greater problem. At present, the Bank Act security is limited in its availability. Only certain categories of borrowers can grant the security, and only certain categories of goods can be given as collateral. A federal Personal Property Security Act would eliminate these restrictions and permit a debtor to grant a federal security interest in all of the debtor's present and after-acquired personal property. This expansion in scope would significantly increase the use of the federal security device, which in turn would increase the number of occasions when a third party would need to conduct multiple searches.

c. Repeal the Bank Act Provisions

The third option would eliminate the federal security system by repealing sections 427 to 429 of the Bank Act. Banks that wished to take security interests in the personal property of their debtors would do so by taking provincial or territorial security interests.

A major advantage of this option is that it results in a more efficient and less complex legal environment. All of the legal uncertainty problems associated with the co-existence of both provincial/ territorial and federal personal property security systems would be eliminated. This option would also have the important effect of reducing the transaction costs of secured financing by reducing search and registration costs. A third party wishing to acquire an interest in the personal property of another would no longer need to undertake dual searches of both the provincial/territorial and the federal registries to determine if property is encumbered. A buyer or lender would only need to conduct a search of a provincial or territorial registry system.

Another major advantage is that it creates a fairer system. One criticism of the Bank Act system is that it creates an uneven playing field that favours banks and disadvantages non-bank credit granting institutions. Banks are able to take both Bank Act security and provincial or territorial security interests to secure their loans, while credit unions, small loan companies and other non-bank lenders are able to take only provincial or territorial security interests. This may allow banks to obtain an enhanced priority position over competing non-bank financial institutions.

Repealing the Bank Act security provisions would, therefore, produce significant benefits that the other reform options do not achieve. It would

• eliminate legal uncertainty,
• reduce transaction costs, and
• establish equal treatment of institutional lenders.

Are there any disadvantages that would militate against imple­menting this option? We conclude that although the Bank Actsecurity played an important role in the Canadian economy at one time, it no longer serves this purpose. When we examine other justifications for retaining it, we conclude that they are weak and do not justify the continued existence of the Bank Act security device.

The original justification for the Bank Act security was that it would promote certain identified sectors of the Canadian economy. At one time, banks were not permitted to take provincial or territorial security interests to secure their loans. This restriction was later removed, but at that time provincial and territorial secured transactions law was in a disordered state and did not provide a fully effective secured transactions regime. This impediment has now been eliminated. In every province and in every territory, a modern secured financing regime has been put into place. Therefore, the original justification for the Bank Act security is no longer valid.

It might be argued that repealing the Bank Act provisions would result in a loss of a long-standing secured financing regime and that eliminating it would make banks change their lending practices. [2] A review of registration statistics provides convincing evidence that this would not be the case. The number of Bank Act registrations effected in Canada is relatively small in comparison with the number of provincial or territorial registrations. Banks are well acquainted with the operation of the provincial/territorial secured transactions regimes and regard the provincial or territorial security agreement as their dominant security device. The Bank Act security is viewed merely as a secondary or back-up security device that will be used only if a problem is encountered with the provincial or territorial security interest. It is, therefore, highly unlikely that eliminating the Bank Act security provisions would result in any significant change in bank lending practices.

The final argument that might be made for maintaining a separate federal secured transactions regime is that it permits banks to make secured loans in jurisdictions that have restricted the enforcement remedies of secured parties. In particular, it might be argued that eliminating the Bank Act security regime would cause banks to reduce the availability of credit to the agricultural sector. To secure their loans, banks would rely on provincial or territorial security interests and would be subject to farm protection legislation that restricts the enforcement remedies of secured parties. The flaw with this argument is that the federal government is constitutionally limited in its ability to formulate a legislative policy that can effectively regulate the credit marketplace. Parliament only has the ability to legislate banks. Pre-empting provincial or territorial legislation will only be effective in relation to banks and not in relation to any non-bank lenders such as caisses populaires or credit unions. This will simply result in a distortion in the market by conferring a benefit on only one class of lenders. To be effective, the regulation must apply to all financial institutions. Only the provinces and territories have the legislative competence to deal with all market participants engaged in secured lending.

Legal experts who have studied the matter have similarly concluded that repealing the Bank Act security provisions is the best option. Surveys of commercial lawyers indicate that this is their preferred option. [3] On April 7, 1997, the Personal Property Security Law Sub-Committee of the Canadian Bar Association – Ontario made a submission proposing the suspension or repeal of the Bank Act security regime. [4] In August 2003, the Secured Transactions Working Group of the Uniform Law Conference of Canada recommended the abolition of the Bank Act security provisions, [5] and at the Annual Meeting of the Conference it was resolved that the President of the Uniform Conference of Canada should write the federal ministers of Justice, Finance and Industry recommending repeal of these provisions. In June 2003, a study paper was prepared for the Department of Justice which also proposed repealing the Bank Act security provisions as the preferred option. [6]

The Commission believes that this option best meets the criteria of the three guiding principles. We believe that repealing the Bank Act security provisions is most likely to create greater certainty in legal outcomes and a more efficient and effective secured transactions regime. This option is best able to take account of the bijural nature of Canadian commercial law. It is also the option that does not frustrate legitimate legislative measures of general application within the provinces and territories.

Recommendation 1

The Law Commission of Canada recommends that Parliament eliminate the Bank Act security regime by repealing sections 427 to 429 of the Bank Act.

1. An alternative to maintaining the separate registry systems would be to eliminate the federal registry system and instead require that the Bank Act security be registered in the appropriate provincial registry. Although this would eliminate the problem of dual registrations and dual searches, it would produce its own set of problems. It would be necessary to specify federal choice-of-law rules which specify which registry system and also to govern situations where either the collateral or the debtor moves from one jurisdiction to another.

2. The fact that the Bank Act security is a federal security device means that banks are able to use the same forms and the same procedures throughout Canada. A bank is, therefore, able to obtain a security interest that is fully effective throughout Canada. However, the current practice is for banks to routinely take both Bank Act security and a provincial security agreement on the same collateral to secure the same obligation. This negates any advantage of having a national registry system.

3. See the Working Group on the Reform of Canadian Secured Transactions, Reform of the Law of Secured Transactions, online: <http://www.ulcc.ca/en/poam2/PPSA_Rep_2003_En.pdf> (date accessed: 3 July 2004); M. Poirier, “Security Under Section 427 of the Bank Act and Provincial Law : Interaction, Harmonization and Reform”, Appendix A.

4. Canadian Bar Association – National Business Law Section, Submission of Harmonization of Section 427 of the Bank Act and the Provincial Personal Property Security Acts (Ottawa: Canadian Bar Association, November 1997).

5. Working Group, supra note 3.

6. Uniform Law Conference of Canada, Civil Section Minutes – 2003 Fredericton, New Brunswick, online: <http://www.ulcc.ca/en/poam2/index.cfm?sec=2003⊂=2003f> (date accessed: 3 July 2004).